Thinking of increasing your wealth and securing your future? The name of the game is “investing”. Investing not just in any kind of asset, but in index funds. Indexfonder.org has given us an easy-to-read rundown of all-things index funds, and why investing in them will benefit you and your family, long-term.
Index Funds Defined
Also referred to as an exchange-traded fund (ETF), index funds fall under a classification of mutual funds. What distinguishes them from the rest is how its holdings are made to keep up with a specific financial market index.
In other words, the portfolios of index mutual funds follow an “index” (hence the term) or a “benchmark”, no matter the current state and status of markets.
Investing in an ETF permits you to potentially create a portfolio that’s diversified. One that has the capacity to work on its own, hands-free. So long as you track the same and/or similar investment types, then you can be assured of good returns. “Good” being a conservative word in this context.
When speaking of central portfolio holdings, index funds are generally deemed as ideal, especially for retirement accounts. This is because said funds can lower your investment expenses. In a sense, choosing such a portfolio in addition to account-combination will bring you “ahead”. This, in parallel to an equally decreased average cost.
How Do Index Funds Work?
Index funds, as they are a kind of mutual fund, automatically implies that you will be pooling your own money along with that of different investors. This “pooled” amount is for buying an asset portfolio. And the purpose of said asset portfolio is to replicate the focal index performance.
When this duplication profits (as it almost always does), capital gains, dividends, and the like are distributed amongst the investors on a timely and regular basis.
With regards to monitoring underlying assets, there are a variety of weighting strategies put into play. These weighting strategies are applied in order to directly affect the performance of an index fund, through asset-tracking.
Market-Cap Weighted Index
The phrase to remember here is “market capitalization”, also called “market cap”. Market cap speaks of the total and/or entire investment amount (total market value) given towards an asset (outstanding shares). It’s an ideal strategy for identifying its share or percentage in the index.
In a price-weighted index, instead of looking at the “totality” of the market value, what’s looked into is each specific part that makes up a portion of the index.
Assets which have a higher price will, accordingly, be allotted a larger share. On the other hand, assets which have a lower price, a smaller share. Think of it as a price-per-share index.
Conclusion: Index Mutual Funds = Excellent Passive Investments
Passive investments revolve around purchasing security that is meant for long-term. Investors who choose such investments do not concern themselves with price fluctuations of a short-term nature, nor do they observe market timing. This job is reserved for active investors who need to constantly be on the market clock.
Since index funds are passive investments, what managers do is simply replicate a “high performance” of the target index. There’s less trading required here, as well as less reliance on too-robust managerial facilitations (hence, lower charges when it comes to you paying for managerial fees).
Even better, index funds are becoming the go-to in the equity market because of the security they offer for a sustainable, long-standing investment and financial future.