Index Funds: What to Know and How to Get Started

Key Takeaways

• Index funds provide a great low risk benefit because of the diversification it comes with.
• You will never outperform the market if you’re investing in an index fund.
• Index funds have a track history of returning an annual return of 9-10% on your investments.

What is a Index Fund, Exactly?

The term index fund, is nothing but a grouping of stocks, bonds, or other asset securities.

Here’s a simple example, the well-known S&P 500 is an index fund of the top 500 publicly traded companies in the United States.

How Does an Index Fund Work?

There are number of different index funds, and they all work a bit different, but in essence an index fund will buy shares of a stock in all of the companies.

The index fund will mirror the performance of the S&P 500–if the S&P 500 goes down, so will the index fund. If the S&P 500 goes up, then the index fund will go up as well.

Imagine it like this, let’s you and your friends are putting your money together to buy a variety of candy. You all decide to buy candy in the same proportion as the most popular candies in the neighborhood. If the most popular candies do well, then they become more valuable , and your candy collection will become more valuable.

Now, if the most popular candies don’t do well, then your candy collection won’t do as well. An index fund works in a similar way, but with stocks.

What Type of Index Funds Exist?

Here are some of the most popular index funds that exist :

• S&P 500: The ETF for the S&P 500 index fund is $SPY.
• Dow Jones Industrial: The best ETF that tracks the Dow Jones Industrial index fund is $DIA.
• Nasdaq: The best ETF that tracks the Nasdaq index fund is $QQQ.
• Russell 2000: The best ETF that tracks the Russell 2000 index fund is $IWM.

Pros and Cons

Pros

• Become a passive investor.
• Consistent results.
• Provides a great diversification and balance your risk.

Cons

• You cannot outperform the index fund and become a superiority investor.
• Lack of flexibility of picking stock: This means when you invest in an index fund, you take with everything it comes or you leave it.
• Index funds doesn’t 100% track its ETF.

Is Buying an Index Fund Right for You?

If you’re the kind of person that wants to maximize your profits, and enjoy doing research on the stock market, then buying index funds may not be the best option for you.

But if you’re the kind of person who doesn’t want to monitor charts, but still want to make money in the stock market, then index funds are the perfect type of investment for you.

How to Buy in 3 Easy Steps

Here’s a quick getting-started guide to investing into an index fund.

Step 1. Purchase an ETF that tracks that Index Fund

If you have a favorite exchange, go there first. Choose the ETF that best tracks the index fund you desire to purchase. Make sure to read on the ETF, and it’s history, before you buy.

Step 2. Hold…

Manage your risk, watch it from every now and then, and hold the index fund.

Step 3. Profit!

Over time a period of time, that index fund you chose will increase in value.

To Sum It Up

Index funds, have are great investments as they have the track record of outperforming nearly everyone who tries to actively manage their accounts. Index funds gives you low risk to market with great returns over the long haul, and is an excellent example of passive income for doing something close to nothing.

Other Asked Questions

What is the Average Annual Rate of Return from an Index Fund (S&P 500)?

The average annual rate of return of an index fund, such as the S&P 500 is about 10% over the last 5 decades.

Over the past 3 decades, the average return is 9%, and over the past 2 decades the annual average rate of return is 10.3%.

Are Index Funds Better During a Bear Market or Bull Market?

Data has proven that during bear markets, it’s better to actively manage stocks rather. Data has also proven that buying index funds are better during bull markets, and to continue riding the wave.

What is an Index Fund Strategy that can be used?

A common index fund strategy that is used is called the Core and Satellite approach. The core and satellite index fund strategy is when an investor, invests the majority of their cash on an index fund, and allocate a small portion to individual stocks that believe will perform well over a number of years.

Are Index Funds Popular for People with Full-Time Jobs?

Yes, investing in index funds is a very common form of passive investing.