Read definition of Index Funds.
An index fund is a a mutual fund or exchange-traded
fund) that aims to replicate the movements of an index of a specific
financial market. An Index fund follows a passive investing strategy
called indexing. It involves tracking an index say for example, the
Sensex or the Nifty and builds a portfolio with the same stocks in the
same proportions as the index. The fund makes no effort to beat the
index and in fact it merely tries to earn the same return.
Origin of Index Funds
Index funds first came into being in the US in the 1970s. In the US the
research established the efficient markets concept which says that
stocks are mostly priced accurately and that it is not possible to beat
the market in a systematic way. Though a few actively managed mutual
funds may beat the market for a while, it is very rare for active funds
to beat the market in the long run.
Advantages of Index Funds
- As per efficient markets concept index funds provide optimum
returns in the long run.
- An index fund doesn't have to pay for expensive analysts and
- Index funds track a broad index which is less volatile than
specific stocks or sectors, thereby lessening the risk for
Index Funds in the context of India
In the Indian market scenario index funds may not be the best option.
The basic principle of indexing is - the more the number of stocks
comprising an index the better is the diversification and price
discovery. Indian indices like the Sensex (30) and the Nifty (50) cover
a relatively small number of stocks and ignore many opportunities in the
mid-cap sector. Also, unlike the capital markets in developed countries,
Indian markets haven't been thoroughly researched and there is enormous
scope to beat the market by sound research.