While learning about investment, ‘index fund’ is a term that may come up very often as it is considered an affordable investment tool.
What are Index Funds?
Index funds are a type of mutual fund or exchange-traded fund (ETF) that are made up of stocks or bonds that attempt to earn the same return as a particular index.
This strategy assumes that the fund's portfolio consists of the same assets that are part of the index it reproduces.
The most well-known index funds are the S&P 500 Composite Stock Price Index, Wilshire 5000 Total Market Index, and Russell 2000 Index.
How do they work?
For example, an index fund on the S&P 500 reproduces the dynamics of the American stock market. By buying one share of this fund, an investor buys 500 shares included in this broad market index.
In addition to the broad market indices that track the market as a whole, there are indices for separate regions, industries and sectors. You can find an index fund for almost any market index.
Like other mutual funds, an index fund can be created based on stocks, bonds, real estate, money markets, and commodities.
In simple terms, index funds allow investors to invest indirectly in an entire market without investing in the stock of the individual companies that it includes.
Advantages of Index Funds
The key advantage of index funds is the ease and convenience of investing.
For example, to form the same basket of securities available in the S&P 500 list, you need significant monetary investments and unlimited resources to monitor and predict the situation on the stock market.
All these difficulties can be replaced by acquiring one unit that is considered ordinary security, similar to shares, and is also suitable for purchase and implementation.
What is more, in order not to depend on a particular issuer, funds provide a balanced portfolio. It means that by investing in the index, you can get a block of shares at a low cost.
Another essential thing is low expenses. Index funds are much easier to manage than their active fund counterparts, their fees are commonly lower. And lower fees mean investors get to keep more investable money in their accounts.
The annual expenses of index funds are significantly lower than those of actively managed funds since there are no costs for managers and costs associated with frequent purchase and sale of securities.
No doubt that there can be some drawbacks in using index funds as well. Do not forget that this is not a deposit in a bank but a risky investment. After the acquisition of the unit, the trader bears all market risks.
However, Investing in an index fund has a reasonably good percentage of profit. The low entry threshold makes this product attractive for beginners who are just getting used to the stock market. And relative stability is for conservatives who choose long-term investment options for their funds.
