Index funds can be an ideal investment vehicle for anyone seeking to build wealth over time, since they’re low-cost and offer diversification.
Contrary to actively managed funds that strive to outperform an index, these passively managed funds don’t attempt to identify winning investments; consequently, their costs may be less than comparable active management funds.
1. Diversification
Index funds can provide your portfolio with much-needed diversification. Many popular index funds track broad indices, allowing you access to stocks you might otherwise not be able to buy on your own. Furthermore, unlike actively managed mutual funds which may diverge from their benchmarks in order to increase returns, most index funds remain true to their benchmarks without trading frequently – an advantage over active management mutual funds which may “style drift.”
Diversifying can help mitigate risk. If one investment underperforms, your portfolio can pick up the slack from elsewhere.
Index fund investors can further diversify their holdings through geographic diversity, business sector diversification and asset class diversification. Investors may select index funds that track companies on foreign exchanges or those focused on specific sectors such as technology, healthcare and energy.
2. Low Costs
No matter if you choose to build your portfolio yourself or use an online brokerage or robo-advisor to assist with it, cost should always be an important factor when selecting your investment products. Your aim should be to achieve maximum return with minimum fees.
Index funds offer an efficient solution to reaching that goal more cost effectively than purchasing individual stocks and bonds, thanks to instant diversification: each purchase of an index fund buys shares in hundreds or even thousands of companies – significantly decreasing your risk of investing all your money in one company at once.
When researching index funds, pay particular attention to their expense ratios. A lower expense ratio means more of your money will end up in your pockets instead of going towards paying fund managers’ salaries.
3. Timely Investments
Index funds offer an easy and low-hassle way to invest in the stock market, which makes them appealing to investors with no time or expertise required to build individual portfolios. But that doesn’t mean setting and forgetting. Becket advises investors to regularly assess their progress and reassess their asset allocation in order to meet their financial goals.
One drawback of index funds is their reliance on a few large companies’ performance, increasing risk when these stocks falter. To reduce this risk, consider investing in socially responsible index funds that exclude companies which don’t meet certain environmental or ethical criteria from being part of the fund.
4. Low Risk
Index funds may help lower your investment risk by streamlining how you meet the asset allocation you’ve selected to reach your goals. They are available both directly from brokers or through automated advisors that provide investment guidance; you can even buy them yourself! They provide diversification while helping create an portfolio.
With just one purchase, you’ll instantly diversify your portfolio by investing in an index’s basket of securities – and over time major indexes have historically generated steady returns – on average 10 percent annually according to NerdWallet ratings.
As with any investment, index funds carry risk. But their long-term gains from low expenses could make up for potential losses in terms of long-term gains and expenses. Before investing, carefully consider your goals, risk tolerance and time horizon and if index funds fit into your portfolio as part of a sustainable solution.
5. Flexibility
Index funds are an ideal investment choice for beginners looking for low-cost investments that have historically outshone many higher fee active traded funds. These passive investments aim to replicate financial market indexes such as S&P 500.
Investors can instantly diversify their portfolio with just one purchase by owning multiple stocks, bonds or assets from an index they are tracking – an effect which helps limit risk by spreading ownership out among multiple holdings of similar size, according to Beckett.
No matter if you build your portfolio yourself, work with an advisor, or use a robo-advisor, your goal should always be a well-diversified portfolio that suits both your risk profile and investment time horizon. Index funds offer lower fees while offering hands-off management – an effective solution to this goal.
