What are index funds?

Views 958KAug 9, 2023


In terms of investment objectives and strategies, index funds are quite different from active funds.

Core points

● index funds correspond to active funds, and the main difference between them lies in their investment objectives and investment strategies.

The ● Index Fund achieves the purpose of tracking the overall performance of a particular index by establishing a portfolio that invests all or part of the constituent assets of a particular index.

Advantages of ● index funds: simpler investments, returns close to the market average, more diversified investments, lower costs, higher transparency, lower taxes, etc.

Disadvantages of ● index funds: following index decline, lack of flexibility, limiting the possibility of returns, tracking errors, etc.

Detailed explanation of concept

Many investment gurus have recommended index funds. Warren Buffett, for example, said in his 1993 letter to shareholders that by investing in index funds on a regular basis, an ignorant amateur investor can often beat most professional investors.

Index funds are also known as "passive funds" or "passively managed funds", corresponding to actively managed funds.

Unlike active funds, it does not need to actively choose which assets to buy, hold or sell in order to beat the market. Index funds use passive investment strategies, which invest in all or part of the constituent stocks (or constituent bonds) of an index based on the weight of the index, tracking the overall performance of the index as closely as possible.

There are different indexes in different sectors of the market. For example, the S & P 500, the Dow Jones Industrial average and the NASDAQ are typical examples.

When an investor invests in an index fund, he actually indirectly replicates the assets that make up the index. He can buy all the constituent assets in a single operation and will get a return similar to that of the index.

Main advantages

Index funds have many advantages.

It is easier for ① to invest in stocks

For those who want to invest in stocks, but do not know what stocks to invest in, it is an investment weapon. Just like riding an escalator, an investor just needs to choose the right escalator. He doesn't have to climb the stairs by himself.

② returns are close to the market average.

In the long run, the returns of index funds are usually close to the market average, which may not be easy for many investors, especially amateur investors. From 1957 to 2020, for example, the s & p had an average annual return of more than 12%, outperforming many single investments.

③ investment is more diversified

Since many companies are usually invested, the index may be less affected by market fluctuations than a single stock, which helps to balance the risks in investors' portfolios.

④ costs less

Index funds are easier to manage and require less management staff and management time, so fees are usually lower than active funds. But not all index funds have lower fees, so you need to know the actual costs of any fund before investing in it.

⑤ is highly transparent

We can easily know the composition of an index from public information, which means that potential investors can also know what the index fund they want to invest in is investing.

Other advantages of ⑥

Index funds do not change their positions frequently, so for investors, taxable capital gains are reduced accordingly, and so are taxes.

In addition, index funds are less affected by human factors, and the resulting decision-making errors are reduced accordingly.

In view of this, index funds are suitable for investors who want to invest in a simpler, lower-cost, stable and long-term investment, as well as financial goals such as education, retirement and buying a house.

Main shortcoming

Of course, index funds have their drawbacks.

First of all, because it is linked to the index, if the index falls, then the index fund will also fall.

Moreover, when there are market fluctuations or market opportunities, index funds are not as flexible as active funds, which may lead to more losses or miss some potential gains.

Therefore, although index funds can reduce investment risk, they also limit your returns. This may be a pity for good investors.

In addition, index funds may not track the index perfectly, and there may be tracking errors, which should be noted in the investment.

Finally, index funds have both advantages and disadvantages, so investors should decide whether to invest in index funds according to their own investment goals.

This material is for teaching use only and is not recommended for investment.

Disclaimer: The above content does not constitute any act of financial product marketing, investment offer, or financial advice. Before making any investment decision, investors should consider the risk factors related to investment products based on their own circumstances and consult professional investment advisors where necessary.