Index Funds are simply
investing your money through a fund that tracks a designated market index,
which is characteristically composed of equities or bonds. They basically
mirror an index such as the S&P 500 index, aiming at generating the same
return of this broad U.S. stocks benchmark.
Index funds or
passive investment confer a number of privileges that make them under the vast
majority of circumstances a good idea worth trial. The following points will
for sure convince you why investing in index funds is worth trial:
- Less Risk: Since your fund will mimic
the performance of a certain market index, you lower your risk compared to
actively managed mutual funds. An index such as the S&P 500, for instance,
encompasses a wide variety of shares from various sectors and thus allows
investors to diversify their fund. A sharp fall in one or two stocks in the
index would not let you experience a huge loss since gains in other shares
should offset at least part of the plummet. Still, index funds offer higher
return compared to bank deposits and refuge assets, reminding that safe havens
involve nearly no risk.
- Broad Scope of Investments: Investors
can buy either stocks or bonds index funds, noting that both markets make up
most of the investments in financial markets. Also, there is an option to
invest in an index fund that covers a certain part of financial markets.
-Lower Management Expenses: Enjoying a
low cost of managing your funds is one of the most attractive aspects of index
funds. In comparison to actively managed funds, index fund managers charge less
expenses as they will mainly pick among stocks or bonds presented in the index
without having to go through in-depth analysis to spot the best investment
chance in the whole market.
-Tax Efficient: Unlike mutual funds,
index fund managers do not have to activate much buying and selling positions,
as they tend to hold a certain asset or a group of stocks for instance for a
long period. Index funds refrain from producing capital gains, which make them
tax efficient in contrast to other types of investment.
-Avoids Market Swings: You should be
less worried about the ups and downs that occasionally occur in financial
markets over the short term, as passive investors mostly focus on the long
growth path to their investments. Any short-term drop in a price of a share
will probably correct upwardly, as market volatility has the propensity to
balance over the long-term.
-Less Need to Figure Out the Best Timing:
Even expert traders could not easily set the impeccable entry and exit points
or, in other words, buying at trough and selling at peak. Having a long run
diversified index fund would eliminate the urge of crawling behind the best
market timing.
-Does Not Require Professional Investors: If
you do not have any experience in financial markets investment or you do not
have enough time to carefully watch economic and financial news, choosing index
funds would be the perfect selection. It could also be a preliminary step into
the stock market that thereafter you can pick your own equities and decide the
level of risk.
Why You Should Not Invest in Index Funds?
-No
Guarantee for Success: For instance, the S&P 500 managed to lock in a
gain of more than 20 percent in the quarter ended June 30, the highest return
since the final quarter of 1998. Yet, in the prior three months, the index
plunged by the same rate, where it is still 4 percent down on the year,
reflecting the large swing throughout the first half of 2020. In 2008, index
funds tracking the S&P 500 cost their investors a loss of 37 percent due to
the fall in the index, in addition to the fund’s expenses. Thus, despite their
relative safety compared to active managed funds, there is no guarantee of
success.
-Never
Beats the Index: One of the key disadvantages of putting your money in
investment funds is the inability to accrue a return higher than the one
achieved by the index, even if you were able to depict a good opportunity.
Therefore, you will end up having a sizable rather than a big gain.
-Inability
to Cut Losses: Mainly, investment funds are capable of helping you to have
a sustainable stream of profit over the long run, but this means that you have
to remain in the market during bull as well as bear market. In other words, you
will have to continue trading at the times of market crashes, which lacks the
merit of preventing your funds from suffering losses and thereby making the
withdrawal decision a rather difficult one.
-Lacks
Picking Your Preferred Stocks: You do not have the luxury to choose stocks
or investing in a certain sector that you prefer, so you will end up having
some shares that you do not like to own. It is like buying a bundle of fruits
that include spoiled and fresh ones and the seller tells you: Take or leave it.
NO OTHER OPTION! Eventually, you may lose the passion of adventure, especially
as index funds limit the exposure to adopt different trading strategies.
Finally, investors should be alert that not all
index funds entail low cost, while the underlying index may change.