What are Index Funds?
Since the inception of Index funds in the year 1976, their popularity and acceptance have proliferated in the business market.
The Morningstar research shows more than $400 billion in investment into this asset class in the year 2021,
If you ever have wonders about this asset class and why people talk about it, attracting the attention of Investors like the Iconic Warren Buffett? Then, keep reading.
This article will explain all about index funds, the high sides and downsides, the various types and where you could get them.
Index Funds Explained
An Index fund is a type of Exchange-Traded Fund (EFTs) and mutual fund, which is made up of a portfolio of stocks that seek to imitate a market index. Simply put, the holdings try to match the current basket of a stock.
This asset class can be created and managed either by professional financial firms (such as brokerages) or the fund Manager.
Index funds are passively managed, meaning that these financial firms do not aim to outperform or compete with the underlying index; rather, they seek to maximize returns gained over time instead of buying and selling securities often.
Meanwhile, actively managed funds carry out more frequent sales as they seek to outperform the market using a certain kind of index.
The money invested is used to further invest in the companies the index comprises, giving a larger portfolio more profitable than individual stocks.
Types of Index Funds
These funds are of diverse kinds, and we shall be considering a few viz:
1. Market Capitalization Index Funds:
Market capitalization is the measure of the total value of the shares of a company. Here, the index is weighted by its market capitalization. An example of this is the SENSEX.
2. Sector-based Index Funds
Here, only businesses of the same categories or industries are invested in, ranging from agriculture to technology to banking and a lot more. Sector-based Index Funds offer a more specific platform for investment.
3. Custom Index Funds
Custom indices allow advisory bodies and institutions to determine strategies for investment while working with their blueprint.
3. Equal Weight Index Funds
There are no variation biases here, whether overpriced or underpriced. Here, every stock weighs the same.
Meaning that all companies in the index would carry the same percentage each.
Advantages
1. Diversification
Investors can gain ownership in different companies with just one purchase of this asset class share based on S & P 500. This way, there is room to earn from different streams.
2. Low Expense Ratio
This is the amount fund Managers charge Investors. The passive management of this asset class has made the expense ratios relatively low and affordable.
3. Ideal for beginners
Since the portfolios are not created or managed by Investors, it becomes easy to make investments with or without sufficient financial knowledge.
Disadvantages
The following are some of the disadvantages.
- There is no protection against losses
- Rigidity (cannot add or subtract from holdings).
- You may never beat the market since the aim is only to match and not outperform.
Conclusion
If you read until this point, we are sure you now have your question answered.
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