The other day, I saw an eye-catching Headline in the Wall Street Journal…“Index Funds Are the New Titans of Wall Street!”
Are they, really?
Well, many “financial coaches” teach “Index Funds’ Investing” as a “Passive Investing” Revolution in the stock market.
If you ask me… I believe that EVERYTHING has a front and a back… Pros and Cons.
In this and the next 3 articles, I am going to cover the good and the not so good of the “Investing in the Stock market Using Index funds” strategy.
So, first of all, Investing in Index Funds is considered to be passive investing as opposed to Investing in Stocks, which is active investing.
Even though Index Funds have a great success in the U.S. Stock Market, they still contribute to only 15% of total holdings. So, whatever you may think of them, Index Funds are not a dominant force of the stock market as a hole.
But let’s start with defining what index funds are.
Index funds are mutual funds that contain a basket of stocks or securities that track the components of an existing financial market index. For example, there are index funds that track the Standard & Poor’s 500 Index (referred to as S&P 500).
Although investors can’t buy an index per se, they can invest in index funds that are designed to mirror the index.
In other words, an index fund tracking the S&P 500 index, would have all 500 stocks from the S&P 500 in the fund.
Therefore, index funds tend to provide investors with
1. fairly broad market exposure,
2. relatively low operating expenses, and
3. usually low portfolio turnover (which helps decrease taxes on capital gains).
So, basically, an average index fund investor is buying all of the S&P 500 companies or other market indices at a low cost.
So far, so good, right?
Now… For beginner investors, hands-off long-term investors, and those who don’t want to spend much time managing their investment portfolio, index funds offer a relatively low-risk way to gain exposure to a wide range of equities.
People who have retirement accounts are likely to invest in index funds because they are considered “ideal holdings” for individual retirement accounts (IRAs) and 401(k) accounts.
I’ve been asked whether index-only investors can lose everything.
Frankly, I don’t think so, because this would entail that ALL stocks in an underlying index effectively go to zero, which is highly unlikely.
As a matter of fact, the total book value of all the underlying stocks in an index fund is expected to increase over the long term.
So, here are again, the 4 main reasons to use Index Funds to invest in the stock market:
1. Index funds offer broad exposure to stock market since they track particular market indices. In other words, Index fund investors are effectively buying all of the underlying index companies (e.g. S&P 500 companies).
2. Index funds’ Investors buy the companies in the underlying market indices at a lower cost than they would pay for actively managed mutual funds.
3. Index funds’ investing is considered a passive investing and they are suitable holdings for tax-deferred retirement accounts such as individual retirement accounts (IRAs) and 401(k) accounts.
4. Since Index funds have inherent diversification feature, index funds’ investors will not lose everything, even during the time of market corrections.
That’s all for Part 1.
Share it with people who could benefit from this information.
In the next week’s article, I’ll talk about 5 Reasons To Avoid Index Funds.
Until next time…stay blessed, stay in your power.
To your health, Wealth, and Freedom.
