An index fund buys every company in an index at the index's own weights and charges little; an active fund pays a manager to pick shares and charges more. An active large-cap fund owns many of its index's shares, so only its differing picks can earn back that extra cost, 0.7 points a year in the example below, before it pulls ahead. On Reema's ₹30,000 monthly SIP, a 1% lag costs about ₹13.4 lakh over 15 years, 9% of the final value, the same share at any SIP size.

What separates an index fund from an active fund?

An index fund, the usual passive fund, copies an index such as the Nifty 50, share for share, so it returns the index minus its costs. An active fund's manager picks shares to beat a benchmark index, landing above or below it.

Cost is the first difference. An index fund's direct plan typically costs about 0.1% to 0.3% a year in 2026; an active equity fund's about 0.5% to 1%. Since 1 April 2026, SEBI's Mutual Funds Regulations, 2026 cap an index fund's base expense ratio at 0.90% a year and an active equity fund's at up to 2.10%, levies such as GST extra.

The second is tracking error: how far an index fund's daily returns wander from its index. Since 2022 SEBI has capped it at 2% for equity index funds and ETFs, over a rolling year. Tracking difference, the gap between the fund's return and the index's over a period, is what shows up in your money.

What does a 1% lag cost Reema's ₹30,000 SIP?

Reema, 34, earns ₹27 lakh CTC, about ₹1,67,100 a month in hand on the same structure as the CTC vs in-hand salary table. She is choosing between a Nifty 50 index fund and an active large-cap fund for a ₹30,000 monthly SIP towards a goal 15 years away: ₹54,00,000 in all.

Assume the index returns 12% a year (an October 2026 assumption, not a forecast). NSE Indices reports that the Nifty 50 Total Return Index returned 12.74% a year from 3 November 1995 to 27 February 2026; past returns do not predict future ones. Instalments go in at the start of each month, the yearly rate divided by 12.

Where the ₹30,000 goes Return after costs Value after 15 years Against the index fund
Index fund, 0.2% cost 11.8% ₹1,48,50,700 none
Active fund, 0.9% cost, picks match the index 11.1% ₹1,38,96,100 about ₹9.5 lakh less
Active fund, 1 point a year behind the index fund 10.8% ₹1,35,09,200 about ₹13.4 lakh less
Active fund, 1 point a year ahead of the index fund 12.8% ₹1,63,49,900 about ₹15 lakh more

The cost gap alone takes about ₹9.5 lakh, so the active fund's picks must add 0.7 points a year just to tie. A 1% lag (one point a year) costs Reema about ₹13.4 lakh, 9% of what the index fund builds. The last row is the case for active management: it pays only if Reema can choose, today, a fund that stays ahead for 15 years.

Does the gap change at ₹15 lakh or ₹40 lakh?

At every salary the lag takes the same 9% of the final value; only the rupee figure grows with the SIP. Same assumptions, with the SIP at about 18% to 20% of take-home:

CTC (in hand a month) Monthly SIP Index fund, 11.8% Active fund, 10.8% A 1% lag costs
₹15 lakh (₹1,00,700) ₹20,000 ₹99,00,400 ₹90,06,100 ₹8,94,300
₹27 lakh (₹1,67,100) ₹30,000 ₹1,48,50,700 ₹1,35,09,200 ₹13,41,500
₹40 lakh (₹2,29,100) ₹45,000 ₹2,22,76,000 ₹2,02,63,800 ₹20,12,200

A regular plan's commission widens the gap; the direct vs regular post weighs whether switching an existing holding is worth the tax.

Why is the index hard for large-cap funds to beat?

The category rules and the fee are part of the reason. Since SEBI's 2017 categorisation, a large-cap fund must keep at least 80% in the 100 largest listed companies, much the same shares its benchmark holds, leaving little room to differ before the fee comes off.

To check your own fund, AMFI's website shows every scheme's direct and regular plan returns beside its benchmark over 1, 3, 5 and 10 years; since February 2018 that benchmark has been a Total Return Index, which counts dividends. Two things flatter that table: merged or closed funds drop out of today's lists, so survivors look better than the category did, and short periods reward luck.

Owning a large-cap fund and a Nifty 50 index fund duplicates many shares; the portfolio overlap post shows how to spot them.

When can an active fund earn its cost?

It can pull furthest ahead where the rules leave a manager room to differ. A mid-cap or small-cap fund needs only 65% in its size band, so its picks can stray from the index far more than a large-cap fund's, either way. Judge one on its five- and ten-year returns against its own benchmark, not one good year.

Between two index funds on the same index, the direct plan's expense ratio and tracking difference decide it; lower is better. The mutual funds guide covers categories and costs; the investing guide shows where an index fund fits in a first plan.

Dhi looks at your cash flow, net worth and protection together and maps each fund, index or active, to the goal it serves. Dhi answers questions from your own numbers and earns no commissions.

Frequently asked questions

A switch is a sale, so the gain is taxed: equity-fund units held over 12 months pay 12.5% on gains above ₹1.25 lakh a financial year, counted across all your listed equity gains, and units held 12 months or less pay 20%, plus 4% cess and a surcharge if total income tops ₹50 lakh (rates from 23 July 2024, unchanged for FY 2026-27). Units still inside an exit-load period may also pay the load. Many investors move the SIP first, which costs nothing, and shift older units in yearly slices.
Both track an index and hold the same shares. An ETF trades on the stock exchange during the day like a share, so it needs a demat and trading account and its price can sit slightly above or below its NAV. An index fund is bought from the fund house at the day's NAV, with no demat account.
No. Both hold shares and fall when the market falls, and an index fund falls with its index by design. What an index fund removes is the risk of a manager's picks trailing the index, not market risk.

This is general information for salaried individuals in India, not personalised financial advice.