How to Invest in Index Funds: Process, Selection, Costs, and Risks

In summary

Index funds are passively managed mutual funds designed to replicate a specified market index. Instead of trying to outperform a benchmark through frequent security selection, the fund aims to maintain exposure that closely follows its underlying index. SEBI's framework recognises index funds as passive mutual-fund schemes, while AMFI describes passive funds as schemes that closely mirror their benchmark.

• Passive strategy: The portfolio follows a predefined index methodology.
• Diversification: One fund can provide exposure to multiple securities.
• Costs: Passive management can result in relatively lower costs than active management.
• Tracking quality: Tracking error and tracking difference show how closely the fund follows its index.
• Investment modes: You can generally invest through SIP or lumpsum, subject to scheme terms.
• Risk: An index fund remains exposed to market movements and can lose value.

The Bajaj Broking website provides access to 4,000+ mutual fund schemes, with investment options available through SIP and lumpsum modes. Your choice should depend on the index, risk profile, investment horizon, costs, and portfolio role.

An index fund is a mutual fund that aims to replicate the performance of a specified index, such as the Nifty 50 or another eligible equity, debt, or hybrid index.

The fund generally holds securities in proportions designed to mirror the index. However, its return will not necessarily match the index exactly. Expense ratios, transaction costs, cash balances, corporate actions, portfolio rebalancing, and other factors can create a difference between the fund's return and that of its benchmark.

This passive approach is also reflected in SEBI's MF Lite framework, which recognises that passive schemes have limited discretion over asset allocation because their portfolios are driven by predetermined index rules.

You can also read about Tracker Funds, which are commonly used as another term for funds designed to track an index.

Investing online generally involves selecting a suitable scheme, completing KYC, choosing an investment mode, and placing the order.

1. Complete KYC: Ensure your KYC is completed and valid before investing.
2. Identify the index: Understand the benchmark, its constituents, methodology, and risk characteristics.
3. Compare funds: Review tracking error, tracking difference, expense ratio, fund size, and other scheme-specific factors.
4. Choose the investment mode: Decide between an SIP and lumpsum investment based on your financial plan.
5. Enter investment details: Provide the amount, payment information, and SIP frequency, where applicable.
6. Review and invest: Check the transaction details, scheme information, applicable charges, and disclosures before confirming the investment.

KYC is mandatory before investing in mutual funds under applicable requirements. The Bajaj Broking website also provides features such as Dashboard, Portfolio, Orders, and MF Profile for managing investments.

You can invest through an authorised mutual fund distributor or the applicable fund-house channel.

The process generally involves selecting the scheme, reviewing its documents, completing KYC if required, filling in the application form, providing bank details, and making the investment through an accepted payment method.

Offline investing does not remove the need for due diligence. The same factors, including the underlying index, costs, tracking quality, risk level, liquidity, and investment objective, should be assessed before investing.

Choosing an index fund starts with evaluating the index itself, rather than simply comparing the names of funds that track it.

Last updated: October 2026

A fund with a low expense ratio is not automatically the best choice. A consistently higher tracking difference may offset the apparent cost advantage, so both cost and replication quality should be evaluated.

Tracking error measures the variability of the difference between a fund's performance and that of its benchmark. A lower tracking error generally indicates more consistent replication, although investors should also examine the actual tracking difference.

A fund can have a competitive expense ratio but still lag its index because of transaction costs, cash holdings, rebalancing effects, taxation on certain transactions, or other operational factors.

Therefore, when comparing two funds tracking the same index, consider both cost and replication quality rather than relying on expense ratio alone.

Index funds can offer several advantages for investors seeking broad market exposure through a relatively straightforward structure.

• Diversification: A single investment can provide exposure to several securities within the benchmark.
• Passive management: The fund follows predefined index rules rather than relying heavily on discretionary security selection.
• Transparency: The underlying index methodology and constituents are generally available to investors.
• Potentially lower costs: Passive management can result in lower expenses than many actively managed funds.
• Simplicity: You can obtain broad market exposure without selecting individual securities.
• Consistency: The investment objective is to replicate the benchmark rather than attempt to outperform it.

However, lower costs and simplicity do not remove market risk or guarantee returns.

Index funds inherit the risks of the markets and securities represented by their underlying index.

Market risk

If the underlying index declines, the value of the index fund can also fall. Diversification reduces dependence on a single security but does not protect the portfolio from a broad market decline.

Concentration risk

Some indices can have significant exposure to particular companies or sectors. A fund tracking such an index can therefore be less diversified than its number of constituents might suggest.

Tracking risk

The fund may not perfectly replicate its benchmark because of expenses, portfolio changes, cash balances, and other factors.

Limited manager discretion

An index fund generally cannot avoid an index constituent simply because its fund manager believes that security is overvalued. The portfolio is primarily governed by the index methodology.

The SEBI Riskometer should also be reviewed before investing. Its six levels are Low, Low to Moderate, Moderate, Moderately High, High, and Very High. The Riskometer describes the scheme's risk level; it does not predict returns.

For a different perspective on passive investing, read Active vs Passive ETF.

Yes. An SIP allows you to invest a predetermined amount at regular intervals in an eligible index-fund scheme.

For example, investing Rs. 10,000 per month for five years would result in total contributions of Rs. 6 lakh before considering returns. The eventual value will depend on market performance and other factors.

An SIP can help automate investing, but it does not remove market risk or guarantee a positive return.

You can use the SIP calculator from Bajaj Finance to estimate potential outcomes under different contribution and return assumptions. Calculator results are estimates and should not be treated as assured returns.

Yes. Investors can make a lumpsum investment if the selected scheme permits it and the applicable minimum investment requirements are met.

A lumpsum investment gives you immediate market exposure, so the timing of the investment can have a greater effect on the initial portfolio value than with staggered contributions. This does not mean that SIPs are safer; both methods remain exposed to the underlying market.

Your choice should be based on available capital, investment horizon, cash-flow needs, and risk tolerance.

Taxation depends on the securities and structure of the index fund. For an equity-oriented mutual fund, applicable capital gains rules generally distinguish between short-term and long-term gains.

Under the current framework, short-term capital gains on specified equity-oriented mutual fund units covered by Section 111A are generally taxed at 20%, while long-term capital gains covered by Section 112A are generally taxed at 12.5% on gains exceeding the applicable annual exemption of Rs. 1.25 lakh, subject to the conditions of the law.

Debt-oriented and other index funds can have different tax treatment. Investors should therefore identify the fund's underlying asset class before applying a tax assumption.

Before placing an order, review the scheme documents and assess the fund against your own portfolio rather than selecting it solely because it has delivered strong historical returns.

• Benchmark: Understand what the index represents and whether it matches your objective.
• Concentration: Check exposure to major companies and sectors.
• Tracking quality: Compare tracking error and tracking difference over relevant periods.
• Costs: Review the expense ratio and other applicable charges.
• Risk: Check the SEBI Riskometer and assess whether the risk fits your capacity.
• Horizon: Match the investment period with the underlying asset class.
• Portfolio role: Decide whether the fund is intended as a core holding or a specific allocation.
• Tax: Understand the applicable tax treatment before estimating post-tax returns.

Past performance does not guarantee future returns. For investors comparing passive strategies, Closet Indexing explains a different situation in which an actively managed fund may closely resemble its benchmark.

Index funds can provide a relatively simple way to obtain market exposure through a passive mutual-fund strategy. The key decision is not simply choosing the fund with the lowest cost, but selecting an appropriate index and evaluating how efficiently the fund tracks it.

Before investing, assess the benchmark, concentration, tracking quality, costs, Riskometer level, investment horizon, tax treatment, and role within your portfolio. SIP and lumpsum routes can both be used, depending on the scheme and your financial plan.

Last reviewed: October 2026

Mutual funds are subject to market risk. Please read the scheme-related documents carefully before investing.