Stop Picking Stocks? Try Index Investing Instead

Added: 2026-05-30

[00:00:07]Hello and welcome to MC Explains, an investor education series brought to you by Money Control and Invesco Mutual Fund. An equity mutual fund scheme offers you a way to invest in tens and hundreds of companies all at once. What if you were shown there is a way to do this without taking the risk of selecting a single stock? It's not a secret formula or magic. It's index investing. In this episode, we will break down index investing, its features, benefits, and risks.

[00:00:41]Let's begin by clarifying what an index is. Think of an index as a market standard measure or a measuring stick for the market. Technically, it's a list of limited number of companies selected on the basis of a defined set of rules.

[00:00:56]A typical market index has companies which are selected on the basis of their market capitalization and each index represents a slice of the broader economy. It's an overall picture of the segment of the economy. For example, the Nifty50 in India tracks the 50 largest publicly listed companies on the national stock exchange. The BSE Sensex is an index that tracks the top 30 listed companies by market capitalization. Benchmark indexes like the Nifty50 or the BSE Sensex are considered representative of the broader Indian economy. When the news says the market is up today, they are usually talking about a benchmark index like the Nifty50 or Sensex. The value of an index goes up when the companies within it collectively gain value. It falls when they collectively lose value. What you need to understand is that no fund manager picks which companies are in the index. The composition is based on predefined rules. For example, benchmark indices like Nifty50 and the Sensex are based on size as represented by market capitalization of companies. There are also sector indexes and other factor-based indices like momentum, quality or value etc. Basically, it's a rulesbased portfolio representing some faction of the market or the economy.

[00:02:29]An index fund is a mutual fund scheme that tries to copy the portfolio of the underlying index as closely as possible.

[00:02:39]Here's how it works. When you invest in an index fund, let's say one that tracks the Nifty50, the fund uses your money to buy shares in all 50 companies in that index in the same proportions as they appear in the index itself. If Reliance Industries makes up 10% of the Nifty50, roughly 10% of your money goes into Reliance Industries stock and so on.

[00:03:06]There is no fund manager who decides what to sell and what to buy. The fund simply follows the index. This is also called passive investing. Primarily, there are two broad types of passive funds. Index funds and exchangeraded funds or ETFs. Both function similarly when it comes to portfolio construction that represents the underlying index.

[00:03:31]But an ETF can only be bought and sold via a stock exchange. Whereas you can buy an index fund just like any other mutual fund scheme either directly through the asset manager or through a distributor in the statement of account form. Unlike with ETFs, with index funds, you do not need a DMAT account to invest. Plus, index funds allow for facilities like SIP or systematic investment plan, which ETFs do not. For most long-term investors, particularly beginners, index mutual funds are the simplest place to start.

[00:04:13]Now, let's talk about what makes index investing popular. Low costs. Since no one is actively researching or trading, the management fees which form a part of the expense ratio are negligible. An active equity fund might charge up to 2.1% annual expense whereas a good index fund might charge up to 0.9% annual expense. That difference compounded over decades adds to your overall returns. Diversification.

[00:04:49]When you invest in an index fund, you own a tiny slice of every company in that index. If one doesn't do well, another which is doing well will make up for the returns. You're not betting on any single business. Indices are automatically diversified. For example, the Nifty50 has 50 large cap companies.

[00:05:12]The Nifty Midcap has 150 midcap companies and the Nifty 500 has top 500 companies.

[00:05:21]Avoid fund manager risk. Index funds don't try to beat the market. They aim to match it. This is done by copying the index portfolio rather than relying on the research and analysis and selection of a fund manager. Over a long period, some fund managers may fail to beat their benchmark index after costs are factored in. By investing in passive funds, you avoid the risk of picking an underperforming fund manager and match the market return consistently.

[00:05:55]Simplicity. When you choose a passive fund, you are not concerned about the strategy, style or process of the asset manager. It is a simple design meant to copy the portfolio of a chosen index.

[00:06:08]This also makes it a standardized product across asset managers and thus makes for easier comparison and choice for an investor. Transparency. When you invest in a passive fund, you have a clear view of the securities and the proportions in which your money is invested in the fund with no active fund manager involvement. No selection bias.

[00:06:32]Passive funds avoid selection bias because they follow a fixed index methodology instead of a fund manager choosing stocks. In short, lower cost, diversification, and simplicity are what you get through index investing.

[00:06:50]Just like everything else in the world, index investing is not perfect. Let's talk about the drawbacks now.

[00:06:59]No alpha. An index fund is designed to match the index, not outperform it. If the Nifty50 returns 12% this year, your fund will return roughly 12%. Less annual expenses. There is never a scope to outperform the broader market. You may find that there are actively managed funds which continue to outperform their benchmark indexes even in the long run.

[00:07:26]and you will miss out if you only focus on index investing. No downside protection. In times of long market corrections or periods where market valuations seem overpriced, an active fund whose portfolio decisions lie with a fund manager may see tweaks in asset allocation and higher cash levels to cushion the draw down in corrections.

[00:07:49]This is not possible in index investing.

[00:07:52]You are always entirely invested in the market regardless of the direction it is headed in. Concentration in large companies. The most popular indexes are weighted by market capitalization, meaning bigger companies take up more of the portfolio. For example, in the Nifty50, the top 10 companies make up for around 50%. And the financial services sector represents 35% of the index. This means that a handful of large companies may dominate space and in tough times a few bad performers at the top can drag the whole fund down.

[00:08:32]No scope to benefit from interim opportunities. Unlike in an active fund where astute fund managers can make up for return shortfalls by taking opportunistic positions that present from time to time, especially in bull markets, index funds function with blinkers on. There is no scope to be flexible even in extraordinary circumstances that may see specific sectors shine brighter. None of these drawbacks should stop you from going for index investing. just that you must be aware. Keep in mind that whether you choose index investing or active funds, the underlying assetbased risk will remain. For example, equity as an asset is volatile in the short term. This risk will show up both in your index fund and an active equity fund. Just like any other equity investment, your equity index fund too requires a long-term horizon for returns to compound and beat inflation. Similarly, your gains in passive funds are subject to the same taxation that other active funds follow.

[00:09:44]Index funds and ETFs don't perfectly replicate their benchmark. This happens because of cash flows that are coming in and moving out of these funds as they are open-ended and investors can choose to add or redeem at any time. The difference between the fund's actual return and index return is called the tracking error. A well-managed index fund keeps this very small, but you should check this figure through the fund fact sheet before investing. Index investing is ideal for that part of your portfolio which you want to keep consistent. It's especially suitable for firsttime investors who are unsure about fund manager selection and the level of risk they want to add. Now with sector and factor-based index funds, even experienced investors can build a more comprehensive equity portfolio using index investing. Hope this video was useful in understanding one more mutual fund related investment concept. Keep watching MC Explains for more such informative videos.

[00:11:01]Mutual fund investments are subject to market risks. Read all scheme related documents carefully.