What are Index Funds?

What are Index Funds?

An index funds is a type of mutual fund or exchange-traded fund (ETF) that tracks a specific market index, such as the Nifty 50. This means that the fund buys the same stocks as the index, in the same proportions.

An index fund is like a simple and cost-effective way to invest your money in a broad range of companies without having to pick and choose individual stocks.

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Why Should You Invest in Index Funds ?

Index Fund are created and used for several reasons:

  • Provides investors with a low-cost way to track the performance of a specific market index.
  • Provides investors with a diversified way to invest, as index funds typically hold a wide range of stocks.
  • Provides investors with a way to participate in the growth of the stock market without having to take on a lot of risk.

How does Index Funds works?

When an investor wants to invest in index funds, it works in the following steps:

  1. Selection of Index. 
  2. Asset Allocation: The index fund allocates its assets in a way that mirrors the composition of the chosen index.
  3. Once you have made a deposit, you can get the shares of the company listed in the Index.

The best way to invest in index funds is to hold them for the long term.

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What impact does it have?

An investor who invests in index fund will affect in various ways. Let’s look at the below table

Low feesIndex funds are typically very low-cost, as they do not require a team of professional money managers to select and trade stocks.
TransparencyIndex funds are very transparent, as you know exactly what stocks are in the fund and how much of each stock is held.
DiversificationBy investing in a broad index, you are spreading your money across a wide range of stocks. This helps to reduce your risk.
IlliquidityIndex funds may be illiquid, which means that it may be difficult to sell your shares quickly.

Let’s see index funds examples:

MonthInvested AmountNAV Monthly Change


In this fictional example, the Nifty 50 Index Fund starts with an initial investment of ₹10,000. The table shows its performance over five months. You can see how the value changes each month, reflecting the performance of the Nifty 50 Index it tracks.

Also Read: Risk Management Definition and Examples