Those investors who are interested in low-fee long-term passive investments should consider index funds. An index fund is a mutual fund that simply tracks the market index. The index funds mirror the performance of the index and keep track of all the necessary activities. Index funds are a good choice for normal investment plans but also for retirement plans.
Index funds are a part of low maintenance income investments. Investors should not worry about a fund manager changing strategies because index funds track particular indexes. The manager does not actively choose the stocks, so it hardly matters who is calling for it. Indexing can be considered as an approach of low turnover so asset growth is not a matter of concern. The index funds usually do not suffer much under the weight of a large amount of assets. Investing in index funds is a good idea because:
- Variety = The index funds are available within all types of investment accounts.
- Low cost = Index funds have low expense ratios, which indicate that fund managers get small portion of the total return.
- Access to exchange-traded funds = exchange-traded funds are easily available to sell and buy throughout the whole trading day. This also attracts new investors.
In order to choose the right index fund, it is important to determine your individual investing priorities. Some of them are:
- Risk tolerance
Investors might have heard of major indexes such as S&P 500 (it tracks the broad basket of the largest companies in the United States) but there are many other options available too. Investors can choose any of them according to their risk tolerance.
- Time horizon and investment objective
The time horizon and the objective of investment are a major considerations in the investment world. If investors think that the stock market is going to take a step up steadily, then it is obvious to stick to index funds that are able to track the major indexes.
- Dow Jones Industrial Average: Almost 30 major multinational corporations are tracked by this index. It cannot be considered a perfect representation of the market as it is small in size. Investors should track this index if they are confident in big companies like Chevron (NYSE:CVX) and Walmart (NYSE:WMT).
- The S&P 500: A large number of big companies in the US are tracked by S&P 500. Investors tracking this index are taking a risk on the overall market.
Investors should start with the checking S&P, Dow Jones Indices and Russell Indexes in order to get a good idea of what is available on the market. After determining the index of their interest, investors can search for funds by seeking help from finance websites or professional brokers. The index funds are available as mutual funds or exchange-traded funds.
- If investment is made through a retirement account like IRA or 401(k), then purchasing index-based mutual funds is the easiest. The availability of exchange-traded funds is combined with regular trading commissions.
- Investors who want to remain active regarding their style of investing, the exchange-traded index funds are a good choice because the trading associated with them is similar to that of stocks.
- A fund must possess low expense ratio.
- It is important for the fund to do a decent job when tracking an index. The performance history of the fund should be properly compared to the performance of the index tracked. Investors can see this comparison in a chart so they can understand the deviations.
- The most important part of choosing the right index is to match the investment objective of the investor. Investors should consider small cap indexes if they want capital preservation along with modest income and high speculative growth.
- The level of volatility differs from funds to funds as some are more volatile than others. Therefore, investors should invest according to their comfort level of tolerating risk.