Index funds grow popular among retail investors — But are they right for you?

Slow and steady wins the race is a saying that most of us have learnt in school. While this may apply to fables, the investor needs to take a call on whether this mindset is something that they want to apply to India’s equity bourses. If so, index funds may match your mindset.

However, some investors might want market-beating returns and windfalls. If this is your investment doctrine, then index funds would likely disappoint you.

“Index funds are booming,” says Chanchal Agarwal, CIO of Equirus Credence Family Office. With the assets in India’s mutual fund industry surging over six-fold to ₹75 lakh crore as of July 2025, and passive investing now accounting for 17% of the total AUM from just 2% a decade ago, they’re clearly resonating.

Much of the inflows come from retail investors through SIPs and sustained inflows.

Index funds are investment vehicles that aim to replicate the performance of a specific market index, such as the BSE Sensex or Nifty 50. These passively-managed funds invest in the same proportion as the index they track, providing you with broad market exposure, according to ICICI Pru AMC. These funds are a great way to achieve diversified investment returns that mirror the overall market performance.

The appeal of index funds is obvious: Low costs, full transparency, and instant diversification. Buy a Nifty 50 index fund and you own the same 50 stocks, in the same weights, as the benchmark.

There is no stock picking that worries investors, and neither is there any manager bias that the actively managed MFs may face.

“Index funds are useful additions to one’s portfolio,” says Anand Vardarajan, Chief Business Officer, Tata Asset Management.

The basic premise of the index (like the Nifty or Sensex, or other similar indices that index funds invest into) is to take the onus or headache of stock selection away from the investor.

An index fund mimics the performance of the underlying indices, note experts.

Indices in periodical reviews pick up and add new stocks while removing those that are no longer making the cut. Thus, the reviews become a self-cleanser, weeding out the weak stocks and adding the strong ones to the portfolio.

Experts cite the grand old Sensex 30, which was dominated by textile companies in the 1980s and had no representation of IT companies. Now, it is teeming with IT and other new-age companies that weren’t part of the Sensex 30 back then.

It is also a good way to buy a full basket of stocks when you are unsure of what to select. It co-owns both the winners and the losers. In the event of stock selection, one may regret the purchase if they happen to pick the wrong stock. An index fund helps spread your risk and takes away the sting of trying to choose what will perform well, note experts.

Now, while index funds do have a lot of good things going for them, there is one thing that by the very nature of their construct, they lack – market-beating returns.

“You (the investor) have zero chance of market-beating returns—you only match the index,” says Ranjit Jha, MD & CEO, Rurash Financials. In the event of market volatility or downturn, active fund managers can rejig the portfolios, which is not the case with passive or index funds.

Also, index funds by their very construct have an overexposure to sectors/companies with high weightage (e.g., financials in Nifty 50).

So, we may assume that the investor who wants stellar returns from the equity markets may probably be disappointed by index funds.

Who should invest in index funds?

“Investor mindset matters. Index funds are best for those willing to settle for market-matching returns, stay invested through volatility, and avoid chasing short-term outperformance. They are not designed to beat the market — and that’s the point,” says Agarwal.

“Be Conservative and Patient,” says Jha. Understand that index investing is a “steady compounding” play, not a quick win. Outperformance is not possible because the returns will not beat the market but mirror it.

Index funds suit those investors who would like to stay invested long term. “In short, treat index stocks as part of your core, low-cost long-term wealth creation strategy,” advises Jha.

Retail investors should adopt a long-term mindset and the discipline to invest and stay the course. As the saying goes, direction matters more than distance; in this case, discipline matters more than returns.

“However, one needs to stay patient for it to deliver results,” says Vardarajan.

Index funds do not help your diversification drive

Investors normally feel that investing in more assets will help to diversify their risk and their portfolio. While this is normally true in most asset classes, this does not hold water in index funds.

“There’s the diversification illusion,” says Agarwal. If you invest in multiple index funds from different fund houses, you may be able to diversify your risk.

The Nifty 50’s top five stocks account for ~45% of the index; financials plus IT make up over 55%. In downturns, correlations spike above 0.9, meaning most holdings fall together.

Market-cap weighting funnels more money into yesterday’s winners.

Many investors think index funds are safer, but this is incorrect. “An index fund carries the same underlying risks as the index itself,” points out Vardarajan.

Index funds remain a powerful low-cost core holding — but they are not “true to label” diversifiers. “True diversification means combining them (index funds) with uncorrelated assets and strategies,” says Agarwal.

“At a portfolio level, if we look beyond equity, I would suggest adding other asset classes that would help in true diversification, like debt, gold, etc,” says Jha.

“Investors may believe that index funds give ‘free diversification’—while in reality, the index may be concentrated in a few sectors. Ignoring costs associated in terms of expense ratios and tracking errors could prove costly,” Jha concludes.

Index funds – taxes and other charges

What is the taxation aspect when selling index stocks? Are there exit loads?

Capital Gains Taxation:

Exit Loads:

• For ETFs→ No exit load, just brokerage.
• For index mutual funds→ Some AMCs may charge an exit load if redeemed within a short time (e.g., 1% if sold within 6–12 months). Always check the scheme document.

Disclaimer: This story is for educational purposes only. The views and recommendations expressed are those of individual analysts or broking firms, not Mint. We advise investors to consult with certified experts before making any investment decisions, as market conditions can change rapidly and circumstances may vary.