What is an Index Fund?

Planning & Saving
on May 13, 2013

In the investment world, there are a number of different funds that you could choose to put your money into. While many investors will search out specific types of mutual funds that follow a certain strategy, others prefer to put much of their money into index funds. What exactly is an index fund and why would you want to invest in one?

Index Fund Basics

An index fund is a type of collective investment scheme that involves following the trends and moves of a financial index. The index fund owns all of the stocks from a financial index so that it replicates the performance of that particular index. For example, the S&P 500 is a financial index of 500 of the biggest companies on the stock market. It is a strong indicator of what the stock market is doing as a whole. An index fund that is based on the S&P 500 would own stocks from all 500 companies in the index. This way, if the S&P 500 goes up in value by three percent, then the value of the index fund would also go up by three percent.

In some cases, index funds are weighted toward the bigger companies. Instead of just buying an equal number of shares of each company in the index, the fund managers may decide to buy more of a particular company.

Who Manages Index Funds?

Index funds are ran by fund managers in much the same way as mutual funds or exchange-traded funds. The fund managers decide when to buy and sell stocks of companies for the fund. When a company is added to or removed from the financial index, the fund managers have to buy and sell a large number of shares to reflect these changes in the index.

Advantages

The major advantage of putting money into this type of fund is that it reflects the stock market. Over the history of the stock market, it has always treated upward. This means that you are getting a share of a diversified portfolio that has a very good chance of increasing in value. If a few companies perform poorly, it is not going to hurt your investment that bad.

Considerations

If you’re looking for a relatively safe investment that will help grow your wealth, the index fund is definitely something that you should consider adding to your portfolio. It isn’t foolproof, but it does have potential.


%d bloggers like this: