The short answer is BOTH. An index fund in the form of a direct plan is one of the best and reliable way to invest if you want market matching returns.
The index fund helps buy a basket of 50 stocks (Nifty index fund) at a very low cost. The direct plan of the index fund reduces your expense ratio further.
Index funds just by mirroring the index have out performed most Large cap funds. If you open the portfolios of most mutual funds, you will see that they hold a large number of index stocks. This is called closet-index hugging.
Anything wrong with the index itself?
Nothing major, expect that a fast growing company may take time to enter the index; much of its growth momentum may be ‘lost’ after it enters the index, unless of course it is a block buster company and the next Amazon of the world.
Similarly if a company declines, it may linger in the index for a long time before getting ejected. In both cases you may not gain majorly as an investor.
Also note that volumes in index funds and ETFs grow, the herds rush into a common territory. This is actually not a bad thing for the average investor, but they may not be able tap great value that lies outside the index.
Is there a better investment strategy?
A direct equity portfolio if managed well is better because of the above structural issues in how index funds work. This increase risk but if the investment strategy mitigates risk then you may consider it.
The Roots & Wings investment philosophy[1] of JamaWealth[2] is one such example. Click these links to know more. This is applicable for investors with a larger sum to invest, preferably as a diversification.
For the average investor, direct index funds are a good vehicle to start compounding wealth. For those who moved up to the next level, a direct equity portfolio would make better sense.
