Why buy an index fund instead of the index itself?

“If I like the Nifty 50, why not just buy the index directly instead of investing in an index fund?”

It’s a valid question. But there’s a catch: you can’t actually buy an index.

An index is simply a number—a performance benchmark made up of a specific group of stocks. It isn’t a security or financial instrument you can purchase. What you can do is try to replicate it by buying all the underlying stocks. But while that sounds easy in theory, doing it yourself is anything but simple in practice. Here’s why:

High costs, high effort

To mirror the Nifty 50 on your own, you’d need to buy all 50 stocks in exact proportions. That means holding large positions in heavyweight stocks like HDFC Bank, Infosys and Reliance. As of April 30, 2025, Nifty 50 stock weightages (based on prices as of May 29, 2025), replicating the index would require at least Rs 8-9 lakh.

And even with that kind of money, you’d still face issues. Share quantities can’t be bought in decimals, so rounding off leads to misalignment. On top of that, you’d need to place 50 separate trades, deal with bid-ask spreads and constantly monitor prices.

Compare that with an index fund, where you can start with as little as Rs 500—or even Rs 100. You get instant diversification without the legwork and the fund handles everything from stock selection to trade execution.

Tracking the index is harder than it looks

Buying the 50 stocks is just the beginning. As market prices move, stock weights change. The index also undergoes rebalancing, as companies may be added or removed.

If you don’t rebalance regularly, your portfolio starts drifting from the actual index. This gap—known as tracking error—widens over time unless you manage it meticulously.

Index funds, by design, aim to keep tracking error minimal. They rebalance automatically and adjust for corporate actions like dividends, mergers or stock splits. Doing all of this manually, without the systems and discipline of a fund manager, is not just tedious; it’s easy to mess up.

The tax trap DIY investors can’t avoid

Every time you rebalance your DIY portfolio, you may need to sell stocks and each sale can trigger capital gains tax. Even small, routine changes can lead to unintended tax outflows.

Index funds shield you from this. Since the fund does internal rebalancing, you don’t pay taxes until you redeem your mutual fund units. And even then, long-term capital gains of up to Rs 1.25 lakh a year are tax-free.

That’s not just a benefit—it’s a smart way to defer and minimise taxes, giving your money more room to grow.

What about index fund costs?

Yes, index funds charge a fee known as the total expense ratio (TER). For basic Nifty 50 index funds, this typically ranges from 0.05 per cent to 1 per cent annually. But this small fee covers the following:

• Automated rebalancing
• Precise tracking
• Tax-efficient structure
• Zero trade execution effort for you

Think of it as paying for convenience, accuracy and long-term discipline—something most DIY investors struggle to maintain.

Final word

The question—“Why not build the index yourself?”—sounds smart at first. But once you consider the cost, effort, risk of error and tax implications, the answer is clear.

You’re not just buying a passive investment when you invest in an index fund. You’re buying efficiency, simplicity and peace of mind.

And that’s not just easier—it’s smarter.

An investor education and awareness initiative of Nippon India Mutual Fund.

Helpful Information for Mutual Fund Investors: All Mutual Fund investors have to go through a one-time KYC (know your Customer) process. Investors should deal only with registered mutual funds, to be verified on SEBI website under 'Intermediaries/Market Infrastructure Institutions'. For redressal of your complaints, you may please visit www.scores.gov.in. For more info on KYC, change in various details and redressal of complaints, visit mf.nipponindiaim.com/InvestorEducation/what-to-know-when-investing.

Mutual fund investments are subject to market risks, read all scheme related documents carefully.

Also read: Are too many index funds a bad investment strategy?

This article was originally published on June 09, 2025.