Index funds: passive investing explained for new investors

Many mutual fund investors are betting on index schemes these days. Several mutual fund houses are also pushing these schemes these days. Low cost index schemes are on the radar of informed investors and they are voicing their preference for these schemes in every mutual fund forum. Are you a new mutual fund investor wondering what the fuss is about, here are some important points that will help you.

How do you know the market is down today? You must have seen somewhere that the Sensex or Nifty is down. You might have also seen pundits speaking about historical returns given by the market based on Sensex’s performance. As you can see, we use indices to gauge the performance of the market or sector- we are not consciously tracking indices but we use them a lot when we talk about performance of the market. We even speak about benchmark indices while talking about mutual fund performance.

So, why not start investing in these widely tracked indices? Well, this is the basic idea behind index schemes. Of course, it is also influenced by the performance of mutual funds over a long period of time in developed countries. Basic idea behind paying a fund management fee in an actively managed scheme is to earn better than the benchmark. However, countless studies have proven that most funds fail to beat their benchmarks continuously over a long period. This once again raises the question: why not invest in an index?


Indian markets have been growing and evolving over the years. With the introduction of standard benchmarks for each category, investors are more aware of the performance of the scheme against its benchmark. For example, most actively managed large cap schemes failed to beat their benchmarks in the last three years. This has forced many analysts and investors to question the rationale behind paying a fee for beating a benchmark.

Some pundits believe that mutual funds continue to beat their benchmarks at least for a decade. They even claim large cap schemes would bounce back once the market returns to semblance of normal behaviour. These pundits believe flexi cap funds, mid cap funds, small cap funds will continue to beat their benchmarks by a considerable margin for the next five years. As the market becomes more mature and all stocks are well-researched, the outperformance of active schemes will become rarer and that is the time to completely switch to index-based investing.

The ease of investing is one of the main reasons why investors abroad choose index-based investing. Low costs charged by these schemes is another major draw. A low cost index scheme is the natural choice of many investors in developed countries. We are slowly reaching there.