Index funds: Benefits of investing in a diversified portfolio

Index funds have minimum risks and increases in value after a while. It requires lower fees than mutual funds and shows better returns.

In this article

  • Index funds have minimum risks and increases in value after a while.
  • It requires lower fees than mutual funds and shows better returns.
  • Index funds are simpler than mutual funds.

An index fund is a type of mutual fund whose objective is to achieve the same return as a specific market index. The primary investment is in the securities (stocks or bonds) of companies included in a selected index. With index funds, you can set up a diversified portfolio with stable returns.

Index funds would save you when individual stocks fall

Suppose you have not heard of the term index before, an index is a measure of the performance of the price of stocks, bonds, or other tradable assets in the broader securities market. Index funds don’t compete with the market or earn higher returns measured from market averages. Instead, buying stocks of firms given on an index would reflect the performance of the index altogether. Index funds would also support you by leveling the risk in an investor’s portfolio when individual stocks fall — as market swings are usually less volatile over an index.

Index funds are unique because it’s an indirect way to gain the entire market. They buy the securities that comprise the complete index. If the index looks for S&P 500, the fund purchases the shares from every company given in the index. Thus, one would get all the shares from the fund, and the value will reflect the gain and loss of the index being tracked.

Many investors are attracted to index funds

Some may say that choosing index funds isn’t wise because you probably wouldn’t do well in the market. Well, a study reveals that more than 90% of active fund managers did not reach the benchmark index between 2001 and 2016. It is obviously better to meet market gains instead of failing by trying to beat the market — index funds are designed to meet market gains.

With the rise of robo-advisors and passive investing, money outflows of active and passively managed mutual funds have reached trillions of dollars; thus, investors have sought index funds in recent years.

While most individual stocks may have fluctuations, indexes always show a tendency to rise over time. You won’t regret investing in index funds — because you wouldn’t lose money in a single investment that goes down. Moreover, the S&P 500 has posted a standard annual return of 10% since 1928. Also, index funds don’t need a fee that would usually consume your returns. The expense ratios — the commissions and management cost of the account — are lower for index funds than managed accounts, because, there is no need for anyone to study your financial statements to guide you on what to buy.

There is more

There’s another advantage: index funds are within reach of a mixed bag of asset classes. Investors can choose funds that emphasize companies with small, medium, or large capital values. They could also focus on a category like technology or energy as well.

These indexes might appear to be less diversified if you compare them with the broadest market index; nevertheless, if you look closely, it is more diversified than buying stock from few companies within a sector. Moreover, index funds diversify your portfolio. Like all mutual funds, index funds give investors a wide-ranging mix of industries and asset classes.

Though investing strategies might seem complex, index funds are simple to understand. They have an unmistakable quality — that means, you cannot go wrong; you can never see something and get something else.

Some well-known indexes

An index fund looks for a specific benchmark index.

Some well-known indexes include The S&P 500 (index of performance of the 500 largest U.S. public companies), The Dow Jones Industrial Average (tracks the most significant 30 U.S. firms), Nasdaq (tracks 3,000 technology companies), The Wilshire 5000 Total Market Index (tracks about 7,000 publicly traded US companies using capitalization or market size), Russell 2000 Index (tracks 2000 small companies with a market capitalization of less than $2 billion). 

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This page is purely informational. Line does not provide financial, legal or accounting advice. This article has been prepared for informational purposes only. It is not intended to provide financial, legal or accounting advice and should not be relied on for the same. Please consult your own financial, legal and accounting advisors before engaging in any transactions.

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