What is Index Fund?

What it is:

Index funds are mutual funds that are designed to track the performance of a particular index. For example, ICICI Prudential Nifty Index Fund tracks the index Nifty 50.

How it works (Example):

When an investor purchases a share of an index fund, he or she is purchasing a share of a portfolio that contains the securities in an underlying index. The index fund holds the securities in the same proportion as they occur in the actual index, and when the index decreases in value, the fund's shares decrease as well, and vice versa. The only time an index buys or sells a stock is when the index itself changes (either in weighting or in composition).
The performance of an index fund usually does not exactly match the actual index's performance. This is because index funds charge management fees, which eat into returns, and because the fund's weighting in particular securities may not perfectly match the weighting of the securities in the actual index. The degree to which the fund and the index returns differ is called tracking error.

Though in theory, index fund is not supposed to charge any fee.

Why it Matters:

Index funds are a popular way to participate in the stock market and diversify a portfolio. Index funds have several major advantages over direct ownership of the underlying securities. Here's a brief review:
1. Diversification
2. Low cost
3. Liquidity
4. Dividends
5. Choices
6. Returns

References:
1. https://investinganswers.com/financial-dictionary/mutual-fundsetfs/index-fund-972