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Pros and Cons of Investing in Index Funds

Pros and Cons of Investing in Index Funds

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.

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