The great thing about investing in index funds is that one doesn't have to be a financial genius to invest in one. In fact an investor doesn't even have to pay much attention to an index fund, after making a careful decision early on. For many investors, index funds offer the combination of risk vs. reward that makes them feel comfortable while still providing the chance to make good returns from a strong market.
What Are Index Funds?
First, let’s make sure we understand what an index fund is. An index fund is a type of mutual fund based on a portfolio of investments that mirrors a larger stock-exchange index. So an index fund may be based on the overall results of the S & P 500, the Russell 2000, or a number of other stock indices. By investing in an index fund, the individual gains the advantage of making money if the overall index goes up without having to pay close attention to individual stocks or funds within that index.
For example, investing in an index fund that focuses on technology stocks will bring positive results if the overall tech sector is strong, even if semiconductor stocks are weak. At the same time, a specific technology fund with a heavy investment in Intel and other chip makers might be doing poorly while a more general index fund is performing well.
They Require Less Attention and Carry Less Risk
Some investment professionals call index fund investing a form of “passive” investing. They point out that index funds often perform better than many mutual funds and that they require less attention. Index funds also usually have lower management fees than other funds. But passivity is in the eye of the beholder. Sure, if one invests in an index fund and never does anything more, then they probably qualify as a passive investor.
But what if a person actually pays attention to the indices? Let’s say they actually follow the broad market, or its niches, and can decide which index funds make sense for them. This is not about day trading, but it is about following trends. The fact is that most mutual funds do not provide a higher return than their broad averages, which are tracked by index funds.
So unless one is willing to do a lot of work, index funds might make sense. The caveat is that a person might do better in other ways. But they could also do worse. Just how much effort are one is willing to put into their investment strategy? That’s an important question every investor needs to ask themselves.
The Bottom Line
One last bit of sage wisdom as one thinks about using index funds in their portfolio. No matter which type of fund one may decide to invest in, there are times when it is going to be down. But if one picks a fund with a history of overall good performance and sticks with it, they can expect to have a portfolio with a solid chance of helping them reach their financial goals. All major mutual fund companies offer index funds, so finding one won't be difficult.
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