If you’ve been paying any attention to the investing world lately, you’ll know that index funds have become a major key player. Since 2016, out of every $5 invested in the United States, $1 was through an index fund.
What is an Index Fund?
An index is an academic concept or an idea. The most famous index of all time is the Dow Jones Industrial Average, commonly known as “The Dow.” This is a list of the 30 largest American publicly-traded companies. Its use is to evaluate the American economy on a day-to-day basis.
Simply put, an index fund is a mutual fund but instead of a manager of a portfolio making the selections, the capital allocation is a job that’s outsourced to an individual or committee who will determine the methodology of the index. When you buy an index fund from The Dow, you’re merely having the the editors of Wall Street manage your money. Or buying an S&P 500 index fund puts the management of the money in the hands of Standard and Poor’s. Either way, you have a portfolio of individual stocks that are managed by a portfolio manager. The portfolio manager is responsible for tracking, which is getting the results as close as possible to the index.
Advantages of Index Funds
As long as the investor intelligently choses a good index that is ran by a responsible and stable asset management company, a single purchase should reap satisfactory benefits. Index funds are also known for their low-turnover rate. Another advantage is that of all mutual funds, index funds typically have a much lower expense ratio.
If you’re someone whose strength isn’t math, index funds have a major psychological advantage. It doesn’t take a strong understanding of math diversification to reap the benefits of investing in an index fund. By their nature, the index funds are already diversified. And finally, index funds stop people from throwing all their life’s savings into a stock they are not familiar with. By the use of outsourced thinkers, financially literate professionals will make these decisions for you.