Basics of Index Funds

Index funds have become an increasingly popular investment. But are they right for you?

We all remember the story of the tortoise and the hare. It was in this tale that we learned a valuable lesson: slow and steady wins the race. The tortoise was not a glamorous creature. He may have lacked pizzazz, but in the end, he won.

In a way, index funds are the modern-day tortoise in the race for a solid investment plan. Nothing flashy, just steadily keeping pace with a particular index, and if, by chance, that index does well, then the fund excels also.

Index funds, which are a type of mutual fund, are a pretty simple concept in the world of investments.  In an index fund, stocks are grouped together from companies included within an index, for instance the S&P 500 or the Dow Jones Industrial Average. The percentage of stock is kept the same as the indexes themselves in an attempt to mirror the index.

About the Dow Jones Industrial Average

The Dow Jones Industrial Average (DJIA) is a price-weighted index of 30 of the largest, most widely held stocks traded on the New York Stock Exchange. The S&P 500 is an unmanaged group of securities considered to be representative of the stock market in general.

Whether or not you want to invest in an index fund depends on the type of investor you are. Keep in mind that index funds are different from normal mutual funds. Most mutual funds are actively managed, so a fund manager is constantly picking new or different stocks to go into the fund. This active attempt to beat the market is based mostly on timing and choosing the right stocks and bonds. Under some conditions, an actively managed account may achieve gains a passively managed account would not. Index funds, on the other hand, are a passive investment, meaning they are not actively managed.

But one of the most attractive parts of index funds stems from the lack of active management. Because they don’t require the same constant administration and attention as an actively managed mutual fund, their expense ratios are generally lower.

Some say if you can’t beat a market, you might as well join it, which is one of the biggest attributes of an index fund. Keep in mind that while an index fund is designed to match the overall gains of the index it follows, it will also participate in the declines. And while the fund tries to mirror an index, the return on the fund will always be slightly less due to management fees.

So are index funds for you?

That depends on your investment style. As always, you should check with a financial professional before investing and decide if index funds fit in with your overall investment strategy. But in the end, index funds offer an alternative way to potentially increasing your wealth and achieving your financial goals.

Investing involves risk, including loss of principal. An investor’s shares, when redeemed, may be worthless or more than the original investment price. An investor should carefully consider the investment objectives, risks, charges, and expenses of a mutual fund before investing. The fund prospectus contains this and other information about the fund. Contact your advisor or the fund company for a copy of the prospectus, which should be read carefully before investing.

Written by Securities America for distribution by Hunt Country Wealth Management.

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