An Index fund tracks the performance of an index by buying all the stocks in a particular index in the same proportion as that index, thereby performing in coherence with the index.
Index funds are passively managed funds whereas other mutual funds are actively managed. Index funds are useful if you are looking for long-term investments with very low costs.
Since index funds do not require a lot of effort in terms of fund management the expense ratios associated with them are also lower.
On the other hand, other Mutual funds require the fund manager to keep a close eye on the portfolio performance and make sure that it consistently outperforms the market on various parameters. This means that the fund manager identifies low-performing stocks, when the situation arrives, and exclude such stocks from the portfolio to replace them with better-performing stocks. This is called rebalancing of a portfolio.
Index funds, on the other hand, do not need so much of active management. These funds invest money in a pre-set portfolio of stocks picked according to the investment strategy of the index fund. In India, we have two popular stock market indices – Sensex and Nifty.
An actively-managed fund always acts towards beating its benchmark. On the other hand an index fund’s role is to match its performance to that of its index.