The Good and Bad of Index Fund Investing
As with any investment, index mutual funds have much to offer, including some degree of risk. They are ideal for novice investors, who do not have the time or energy to thoroughly evaluate and follow actively managed funds. Index fund investing also will benefit experienced investors, who are in search of a greater sense of balance for their portfolio. Ultimately, with a basic knowledge of the unique role of index funds, their potential performance, and inherent risk, they can enhance almost any investment strategy.
What is an Index Fund?
An index fund is invested in stocks, or other instruments, which make up a particular index. An index is a financial benchmark. It tracks a large number of equities, bonds, or other financial securities, as a whole. It serves as a measuring point for financial markets. For example, the S&P 500 follows 500 large American stocks, the Russel 2500 measures the overall performance of small to mid-cap American stocks.
By following an index, a mutual fund is not relying on the expertise or a human being, but rather the strength of the segment of the market being covered, in general. If the index grows over time, so too would the fund that invests in all of the stocks tracked by the index.
The Benefits of Investing in Index Funds
Why invest in index mutual funds? There are several reasons. First, they are passive, and therefore do not require the constant work or a fund manager, nor the expense of a manager. They should be a less expensive choice, as compared to actively managed funds, therefore making it easier to earn a profit.
Second, they require less effort. There is no reason to follow or worry about the decisions of a manger, to make sure a fund is not suddenly managed differently, or to research how a fund is handled in the first place. An index mutual fund is only handled by the inevitable highs and lows of the market.
Third, they represent the performance goals of other mutual funds. An actively managed fund does well if it beats the indexes. Why not simply invest in the standard itself? When searching for what mutual fund to invest in, if an active fund is not able to beat the index it is most related to, it is probably wiser to simply invest in the index mutual fund itself.
Risks of Index Mutual Funds
As long as the market that an index fund is tracking is growing, than index funds should be a safe bet. On the other hand, if the overall economy is not strong, investing in index mutual funds may lead to steady losses instead of steady gains. There is no active management constantly trading stocks to find the best possible opportunities. There is only the general fate of the investments involved. If a benchmark, such as the Nasdaq for example, loses points for consecutive years, than a related fund will show the same results.
How to Choose the Best Index Funds
What are the best index funds? Some involve large-cap stocks, others, less noticed short-cap equities, while other funds integrate international markets. There are over two hundred choices, ranging from the stalwart 500 index funds, to the slow and steady bond index funds, to customized funds such as the Domini Social Equity, which does not invest in alcohol, tobacco, or firearms.
Research the performance of potential mutual funds, look over the specific content, and make sure fees are within reason. There are enough opportunities in index mutual funds for any investor. The right choice is the one that will add balance to an investment portfolio.