Most people don’t have the time, much less the wherewithal, to oversee the day-to-day activities and performance of their portfolio. So, they rely on expert opinions, advice, and management, which, then again, have different levels of involvement available. This is the case with mutual funds. Investing in a basket of securities, or debt that is administered by a third-party manager can be a good option for you. But then, how involved do you want that manager to be? With index funds, you rely more on market indicators than on your fund manager’s research and analysis.
What are index funds?
Index funds are usually linked to specific benchmarks, usually an index or grouping of stocks, bonds, currencies, commodities, etc. This is unlike non-index funds that have fund managers who actively review and adjust the funds’ holdings. Non-index fund managers will attempt to better market performance, while index funds, because they are following market indicators, will try to match the market.
The idea behind index funds is that the market, over the long term, tends to go up. The S&P500 has had an average annual return of about 9.5% since its start in 1926. Gold prices have increased over 50% in the last ten years. The FTSE 100 returned just under 9% in the past decade. So, identifying and following an index doesn’t guarantee success, but it does have a good example to follow. This is because some funds won’t replicate the index (i.e. buy exactly the same securities). Rather, they’ll invest in either a sampling (so not the entire 500 companies in the S&P500) or in companies that may not be on the list but have a similar profile.
Are there downsides to index funds?
Many investors love index funds because they tend to have lower fees and they feel like they’re more stable (because of the index connection). But you should still be careful. The S&P500 may have performed well over the years, but there were some years when things did not go well. Also, make sure you understand how the index fund works. Will it replicate the index you want followed? Or will it pick similar companies? If so, how does it decide what is similar? So, while index funds are an attractive investment option, you may want to chat with a trusted financial expert, like Richard Cayne at Meyer International, to discuss your options.