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What are index funds and how do they work?
An index fund is a type of mutual fund that tracks the performance of a market index such as Nifty50. And investing in index funds means buying a fund that follows the index's performance. Simply put, an index funds track and try to match the returns of the index.
Instead of being actively managed by a fund manager who picks individual stocks, these funds passively track an index by investing in the same stocks and in the same proportion as the underlying index.
How Do Index Funds Work? Index funds do not require active stock selection or market timing. They aim to match the performance of the index rather than beat it.
Since there’s no active management, operational costs are lower compared to actively managed funds, resulting in lower expense ratios and they are seen as a great way to gain exposure to multiple sectors and industries represented in the index. It basically reduces your risk through diversification.
Returns of an index fund are linked to your market performance. If the index rises, the fund generates similar returns; if the index falls, the fund also declines.
Automatic Rebalancing: When the composition of the index changes (e.g., a stock is added or removed), the fund automatically adjusts its holdings to maintain alignment with the index.
Also read: Index Funds