What Are Index Funds And How Is It Better Than Most Actively Managed Funds

An index is a statistical measure of the changes in the value of list of stock prices which are considered to represent the whole market. An index will help you check the performance of country’s stock market and compare your portfolio’s market. However, these index figures don’t appear magically appear. There are various organizations that are involved in index services. These companies, not surprisingly, are known as index providers or index company. They are not only involved in index calculation but also index development and maintenance, making sure that they reflect any changes in the economy, market, and investor’s sentiments.

Now, that the basics of indices are covered. Let’s move on to the investment strategy that’s a result of index. The investors today are familiar with the term, Index Investing. In this, what you simply do is invest in something called, Index Funds. These funds can be thought of as mutual funds which are based on a specified index and you try to create a portfolio which mirrors the index’s performance.

Like Index funds, mutual funds are aimed to beat the performance of market by diversifying the investment. However, most of the mutual funds fail to outperform the market index. The main reason of mutual fund’s underperformance is the cost that mutual fund charges. Such actively managed funds tend to charge higher to investors in order to cover their own cost.

The main advantage of index funds is lower management fees. This helps in higher returns than most actively managed funds. Since, index funds follow the average, they spend very less. This is reflected in the total returns of your fund. The reason behind this lower cost is that the fund is not actively managed. The fund managers only need to maintain the appropriate weightings of the stocks in the selected index to match its performance.

Once you invest in index funds, you are guaranteed market average returns. However, do not be misled! There are risks as well. You’ll lose in a bear market and go up in bear market. The important thing to remember is do not sell in bear market, you might miss the return of recovery.