Index funds with low expense ratios, or annual management costs, are a type of pooled investment. Since money lost to fees is money that is no longer compounding on itself in your investment account, investors who concentrate on limiting their investing costs can produce much greater returns over time.  

Since they have lower cost ratios and are tax-efficient, index funds, a form of an exchange-traded fund (ETF), is preferred by many investors over mutual funds. Because they are passively managed, index-tracking ETFs often have low expense ratios. This lowers operating costs. Active trading and internal stock analysis are not necessary for passive investing strategies.

The two methods for investing in equities are actively investing and passive investing. With passive investing, one copies the benchmark index exactly, while with active investing, one carefully selects stocks for their portfolio. Passive investors eliminate unsystematic risk by mimicking the weights of the index's components. The fund managers are not permitted to invest outside the index's listed companies or deviate from the index weights. Investors may invest in benchmark indices through a low-cost index fund, which makes it simple for them to match their portfolio's exposure.

The weighting of index constituents in a fund is the same as in the benchmark index itself. The index fund replicates the changes in the index and tracks them in the fund portfolio. Since the index fund mirrors the benchmark index, investors may generate similar returns by investing in index funds. Indices such as BSE S&P Sensex, NSE Nifty 50, and Nifty Midcap100 are tracked by index funds. Since index funds maintain a passive investment strategy, their management fees are lower than active funds. A lower-cost investment alternative is provided to investors seeking a broader exposure to benchmark indices.

Returns from low-cost index funds

Low-cost index funds typically have zero alpha, as there is no diversification within the investment portfolio beyond the index's structure. Because the construction of benchmark indices is based on time-tested strategies, investors may prefer to emulate the benchmark returns rather than seek to outperform them. For example, an index fund tracking the S&P BSE Sensex might generate the same returns as it did in the previous year, provided that it accurately tracks it.

Taxation of Index Funds

Index funds that replicate benchmark indices are taxed according to their composition. Index funds replicating equity indices are taxed as equity-oriented funds. Index fund gains on investments held for less than 12 months are taxed at a special 15% tax rate (in addition to the normal tax rate and surcharges). If the investment has been held for at least 12 months, the investors must pay tax at 10% (plus surcharges and Cess) after availing an exemption worth Rs. 1 lakh towards LTCG on equity shares and equity funds collectively. Low-cost index funds are an attractive investment option for investors seeking exposure to benchmark indices as opposed to relying on fund managers' stock selections.

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