What is an index fund?
Mutual funds follow two types of investing methods. One is active investing where the fund devotes time and effort in order to detect and buy quality stocks. Most of the funds fall in this category. The other is passive investing. It is far simpler and consists of just tracking the benchmark index. This strategy is followed by index funds. These funds constitute their portfolio using the same stocks and in the same ratio as found in the index. These funds simply mirror the index. So their returns are in the same line as the returns generated by the index. They will never outperform the index. What are the pros and cons of these funds? These funds do have their own pros and cons. Here are the pros and cons of these funds. Pros: • Lower costs: As these funds employ buy and sell strategy actively, they do not incur heavy trading costs and analysts’ fees. • Knowledge of portfolio: Since these funds track their benchmark index, they hold the same stocks in the same ratio as are present in t
Index funds are mutual funds that buy and hold the stocks that comprise a market index. Thus by investing in funds that mimic the S&P 500 stock index, for example, you will achieve some measure of diversification in 500 widely held stocks traded on the New York Stock Exchange, the American Stock Exchange, and NASDAQ. Index funds are passively managed, which means they purchase or sell shares of stocks only when the index replaces stocks or when investors buy or sell shares of the fund. Unlike actively managed funds, index funds do not attempt to buy stocks based on the fund manager’s outlook for certain companies or for the market in general. The passive approach of index funds generally means the expense ratio of index funds is substantially lower than that of actively managed stock funds. The average expense ratio of index funds was 1.00% in 2008, compared to 1.21% for actively managed funds.1 The higher management expenses of actively managed funds makes it more difficult for them t
