Key idea
A fund that simply copies an index, holding the same companies in the same proportions. Low cost, broad, and refreshingly boring.
You met index funds in the last domain; here is how they work as products. An index fund mechanically holds every company in an index (like the Nifty 50), in the same weights, and simply mirrors it. No manager tries to beat the market; the fund is the market, minus a small cost.
Why they are popular
Low cost
no expensive manager
Broad
the whole index in one buy
Simple
no stock-picking to judge
The one metric unique to them: tracking error
Since an index fund aims to copy an index, the question is how closely it manages to. The small gap between the fund's return and the index's is called tracking error. A good index fund keeps this low, meaning it faithfully delivers the index's return minus its tiny cost. A low expense ratio and a low tracking error are what make one index fund better than another.
Index funds turn "own the whole market cheaply" from a principle into a product. When comparing them, look at expense ratio and tracking error, since the index they follow is the same.
Finished reading?
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