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You are here: Stocks Investing Guide >
Mutual Funds > Index Funds |
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Index Funds
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Index funds are mutual
funds that are based on investing in the companies
that make up a particular stock market index; the
Dow Jones, the AMEX or the NSADAQ for example. One
example of an international index fund might be
the TSX 300. International investment is often
considered an unwise choice, but some funds also
represent companies from overseas, and of course,
many U.S. corporations have offices in other
countries.
Small cap index funds like Vanguard Small Cap may
follow up-and-comers like the S&P 600, and
mid-caps are represented by index funds that
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track the S&P 500. The
idea is that, if you buy stock from the same
corporations and in the same proportion as it's
represented in the stock index, you will do at least as
well as that index, and after factoring in dividends,
maybe even better. Index funds are known for having
lower expenses because instead of having managers who
pick stocks and decide how many shares of each company
to buy, the index are already decided by looking at the
index. The issue of market timing also lessens because a
fund based on the makeup of the index will move just
behind it. People involved in day trading, which
involves buying and selling stocks on a moment-to-moment
basis will be much more concerned with the ups and downs
of an index than the usual investor.
Instead of being balanced in terms of stocks and bonds,
the index fund is balanced based on a given index: you
might say it is diversified toward success, since its
companies are the best of the best.
Index funds are very popular: the S&P 500 Index Fund is
one of the top two biggest funds in the world. People
like index funds because they are more reliably managed
than other funds: as long as the stock market is holding
steady, these funds should do so as well. You can pretty
much count on getting a return of around 10%, which
isn't spectacular, but is just fine, and without the
drama of watching a single stock or a
weirdly-diversified fund rise and fall.
Don't let a financial advisor talk you into paying big
fees or high expense ratios for an index fund, even if
it's the "gold standard". Integrity is an important
commodity in an advisor, and there's probably an inverse
relationship between the amount of searching you do to
find a good advisor and the amount of work you have to
put in watching your investments afterward. You can and
should buy no-load index funds: they are still financial
products, and you can still lose plenty of money in
"just" a 1% increase in expense ratios. With no-load
funds, the expense ratio has to stay under .25%, which
is reasonable and won't cut into your investment.
Index funds' stability is also pretty good because the
big companies that make up a particular index don't fall
off the index very often and are usually engaged in
steady growth, so there aren't many replacements. As
long as a corporation is still in the S&P 500 or the
Dow, or whatever the tracking index is based on, it's
going to stay in the fund.
Finally, don't confuse the definition of index funds
with hedge funds. Hedge funds are for wealthy investors,
and often require initial investments of more than
$25,000. They use aggressive and risky measures to
maximize profit, and they aren't for the faint of heart
or the average wallet.
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How to stick to a household budget
and have extra
money for investing
1. Customize your budget with your current needs, wants and future goals in mind.
2. Try to think if your budgeting plan as a "spending" plan rather than penny pitching.
3. Sit down and rationally discuss budget goals and spending limits with your spouse. You are bound to disagree somethere, but it important to take the time to find common ground.
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