Index Fund

By
rjonesx
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Definition

An index fund is a mutual fund or exchange-traded fund designed to follow certain preset rules so that the fund can a specified basket of underlying investments. Those rules may include tracking prominent indexes like the S&P 500 or the Dow Jones Industrial Average or implementation rules, such as tax-management, tracking error minimization, large block trading or patient/flexible trading strategies that allows for greater tracking error, but lower market impact costs. Index funds may also have rules that screen for social and sustainable criteria.

Index Fund

An index fund is a type of mutual fund with a portfolio constructed to match or track components of a market index like standard and poor’s 500 index (S&P 500). An index mutual fund provides broad market exposure, portfolio turnover and low operating expenses.

Breaking down Index fund

Indexing is a rather unreceptive form of fund management that is successful in outperforming most actively managed mutual funds. The most popular index funds track the S&P 500 and a number of other indexes, which include Russell 200 small companies, DJ Wilshire 5000 total stock market and Barclays Capital Aggregate Bond Index total bond market are widely used for index funds.

Investing in an index fund is a form of passive investing. The primary advantage to such a strategy is lower management expense ratio on an index fund. Majority of mutual funds fail to beat broad indexes like S&P 500.

Features of Index fund

If your partner of spouse does not want to put in time and work to understand investing, index funds make it easy. Actively managing funds are complex and challenging than index funds. There are various ways to build actively managed portfolio and it is virtually impossible to prove in advance which one is the most effective one. Index funds do not work this way.

Index funds do not call for lot of cash on hand. As anybody who invests in money marker funds knows only too well, cash is a low return investment.

Investors in index funds tend to be patient investors. This means that these funds don’t usually experience heavy outflows of cash in bad times or heavy inflows in good times.

Once you commit your investment strategy to index funds, you will never need help of a securities salesperson. This means that you eliminate a source of advice that is potentially bad and it could easily cost you hundreds of thousands of dollars.

Conclusion

Many investors seem to think that investing is difficult and complex. Index funds however are easy to understand. These funds make no promise except to represent a particular asset class, the investor’s only challenge is to determine the best asset classes and find funds that track those assets with low expenses.

Further Reading

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