In plain words
What "passive" actually means
An index is a list of companies chosen by a fixed rule, for example the 50 largest listed companies by size. An index fund buys exactly that list and nothing else.
When a company enters the index, the fund buys it. When it drops out, the fund sells it. Nobody at the fund decides that a share looks cheap or that a sector looks exciting. Your return is the index return, minus a small cost, minus a small slip called tracking error.
That is the whole idea. You give up the chance of beating the market. In return you avoid the risk of a manager doing worse than the market, and you keep more of what the market gives.
Why cost matters
A 1.3% difference in cost, over 20 years
Same ₹10 lakh invested once, same assumed rate for illustration of 12% a year before costs. Only the yearly expense differs. The fee comes out every single year, so it compounds against you.
Yearly cost 0.2%
₹93.1 lakh
Yearly cost 1.5%
₹73.7 lakh
Left behind in fees
₹19.4 lakh
That is almost twice the money you put in. An active fund can still be worth it, but only if it beats the index by more than its extra cost, consistently.
12% is an assumed rate for illustration, not a forecast; real returns vary and can be negative. Mutual fund investments are subject to market risks, read all scheme related documents carefully. Past performance may or may not be sustained in future.
Index fund or ETF
Two ways to own the same index
An ETF is an index fund that trades on the stock exchange like a share. Same idea, different plumbing. Which one is easier depends on whether you already have a demat account and how you like to invest.
| What you care about | Index fund | ETF |
|---|---|---|
| Demat account | Not needed | Needed, plus a broking account |
| Monthly SIP | Yes, automatic from ₹500 | Only by placing buy orders yourself, or through a broker's plan |
| Price you get | End of day NAV | Live market price, which can sit slightly above or below the real value |
| Yearly expense | Low | Usually a little lower |
| Other costs | Usually none | Brokerage, and the gap between buy and sell price |
| Thin trading risk | None, the fund buys back units | Small ETFs may have few buyers, so check daily volume first |
| Usually suits | SIP investors, first-timers, goal-based plans | People who already trade shares and want the lowest running cost |
Tracking error
The one number to check before you buy
Two funds can track the same index and still give you different results. The difference comes from cost, from cash the fund holds for redemptions, and from the delay in buying when the index changes.
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Tracking difference
How far the fund's return was below the index over a year. It is roughly the expense ratio plus some slippage. Smaller is better; under 0.5% a year is reasonable for a large cap index fund.
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Tracking error
How much that gap jumps around from day to day. A fund with a steady small gap is easier to live with than one that is sometimes ahead and sometimes far behind.
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Fund size
Larger funds spread their fixed costs over more money and handle big redemptions more smoothly. We look for a fund with several years of record behind it.
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For ETFs: volume and spread
If few people trade an ETF, you may pay above its real value when buying and get less when selling. Check that it trades every day in decent volume.
Core and satellite
You do not have to choose one side
Most of our clients hold both. Index funds form the steady core. A few active funds sit around it, in areas where a manager has more room to add value, such as mid and small companies.
Cautious, first equity fund
Large cap index fund as the core. A flexi cap fund for the rest. Two funds, easy to track.
Balanced, 10 years or more
Large cap index core, an active mid cap fund, and a small slice in an international or next-50 index for spread.
Hands-off, lowest cost
Large cap index plus a mid cap index. Almost no manager risk and the lowest yearly cost of the three.
- Index funds (core)
- Active equity funds
- Other index or international
These mixes are examples for the equity part of a portfolio only, not a recommendation for you. Your debt and emergency money sit separately. We set the split after a risk profile conversation.
Good fit
Index funds usually suit you if
- You want equity exposure without tracking a fund manager's calls every year
- Your goal is at least seven years away and you will stay through the falls
- You are starting with a small monthly SIP and want low costs from day one
- You already hold three or four active funds that overlap, and want to simplify
Think twice
They may not be right if
- You need the money within three years; an index fund falls exactly as much as the market
- You expect someone to move your money to cash before a crash; an index fund never does
- You plan to buy a narrow sector or theme index you have heard about from friends
- You keep switching funds; low cost helps only if you stay invested
Talk to us
Ask which index fits your goal
Tell us your monthly amount and how long you can stay invested. We reply on WhatsApp with a suggested index and active split, explained category by category.
- We look at overlap with funds you already hold
- We show the tracking difference of the shortlisted options
- No charge for the first conversation
Are index funds safer than active funds?
No. An equity index fund carries full market risk. In a year when the market falls 30%, your index fund falls about 30% too. What it removes is manager risk, the chance that a fund does worse than the market because of poor picks.
Will an index fund always beat an active fund?
Not always. Some active funds beat their index in some periods, especially in mid and small companies. The difficulty is knowing in advance which ones will keep doing it. That is why we use index funds for the core and active funds where a manager has more room.
How are index funds and ETFs taxed?
Equity index funds and equity ETFs are taxed like other equity funds: gains on units held over a year are long-term, with a yearly exemption limit, and shorter holdings are taxed at a higher short-term rate. International and some other index funds are taxed differently. Rules as of 2026, check current rules; we confirm them with you before you invest.
Which index should I start with?
For most first-time investors, a broad large cap index of the 50 or 100 biggest companies. Narrow sector or theme indices move much more sharply and are best kept small, if used at all.
Can I start an ETF without a demat account?
No. ETFs trade on the exchange, so you need demat and broking accounts. If you do not have one, an index fund that tracks the same index does the same job and allows a monthly SIP.
Related
Read next
Pages that pair well with an index fund decision.
Equity funds
Large, mid, small and flexi cap active funds explained.
Index vs active, in detail
Our longer blog post on when each one earns its place.
International funds
Index funds that hold companies listed abroad, and how they are taxed.
Portfolio review
We check overlap and costs across every fund you hold today.
SIP
How a monthly SIP into an index fund works, with step-up.
Want a low-cost core for your portfolio?
Mutual fund investments are subject to market risks, read all scheme related documents carefully. Past performance may or may not be sustained in future.