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What are Index Funds? The Pros and Cons

Do you want to earn money without spending that much? Sure that you do. How about being involved with the largest companies' stocks in the stock market even though you are not an economist, or you are not knowledgeable of how stock index funds grow and gain profit in the market? So before jumping in to a move, make it sure that you have researched well and have analyzed the system of investing in stock index funds. Well, this article may give you an overview on what stock indexes are without having you to consult from portfolio managers who would charge you with such fees.

What's An Index Fund?

An index fund is an investment scheme done by a group of investors who aim to achieve investment returns similar to those of the index of an existing market index. This is a collective investment venture that is considered passive. They are never actually managed by an investment manager, and would merely track a specific stock market index. This is in opposition to the actively-managed funds or in active investing wherein investment managers themselves are buying and selling stocks in order to exceed the performance of a model stock index.

How it Works

Investors pool together their monetary resources into the index fund. Thus, it is also called mutual fund or exchange traded fund. The collected money is invested using a passive management strategy. Here, the pooled money is invested in accordance to a planned strategy. The investors no longer finds the need to predict the trend of the stock market and will instead imitate the trends in another specified index (which is usually that of an actively managed fund).

Regardless of the external market conditions, the trends in an index fund remains constant and will continue to imitate or track the movements of another in the market niche for which it was created.

Investing in an Index Fund

A considerable amount of money is needed before a person can become an investor in an index fund. Each index will have its own minimum investment requirement. While some will require at least $10,000 minimum, more are offering investment opportunities at an initial investment of $3,000.

Terms of Investment Returns

The returns that an investor will get from index funds depend on the class or category that he or she agreed to upon entering the investment venture. Most of the time, an investor's category is determined based on the amount of his or her initial investment. Needless to say, the end-of-year returns will be directly proportional to the invested amount. The smaller the initial investment, the smaller the returns at the end of the year; the same thing goes for larger investments.

The following are some of the most successful mutual funds recommended by finance and index experts:

1. Fidelity Spartan 500 Index Investor

2. Vanguard 500 Index Investor

3. T. Rowe Price

4. Standard and Poor 500

5. Profunds Bull Investor Fund

6. Russell 2000

The Standard and Poor or S&P 500 is the most widely-owned index fund in the United States. It is, in fact, serving as a model index for other index funds, just like the Profunds Bull Investor Fund. It is therefore possible for an index fund to use another index fund as its basis.

Advantages of an Index Fund

As already mentioned above, the investors for this type of fund do not actively manage the investment by buying and selling stocks. It therefore saves investors the stress of determining which move will be more profitable, or trying to correctly predict the trends in the market.

Because of this lack of active management, these funds generate lower charges for service fees and taxes.

What are stock index funds? Do they come in the form of money? Stock index funds do not come in the form, but they could in turn make money for you. These are mutual funds that keep a portfolio of stocks from a market index, an index is a group of securities that can be representing a common sector or a portion of the market, such as the stock and bond markets, that track or mirror the movement of an index. The tracking works by buying securities or all of the securities in the same proportions as the index and holding them in a portfolio that makes the ownership held in constant. A mutual fund can be managed in two ways, first is the actively managed funds, mostly preferred by companies and then the passively managed funds or the index funds, which over the years has grown its popularity among individuals who want to venture in the finance market. Actively managed funds aim to be greater or top the returns of the index by analyzing and assuming when to buy and sell stocks that you think would do big in the market, also known as stock picking which has drawn risks to investors because you do not really know when you can beat the market. On the other hand, the stock index funds or the passively managed funds target to only match the return of a market. Unlike the stock index funds, actively passive managed funds are being monitored by brokers or fund managers to which they ask for a percentage of commission and a managerial fee from the investor that could in turn diminish the returns to the one who invested. The advantages of investing in an index fund are the non-requirement of corporate analysis, you let the market do its work, you can just monitor how your chosen index has been working by reading through newspapers or over the internet; it has almost non-existent expense ratio, because you do not need to hire a fund manager, less expenses more returns; and a reduced company specific risk because of the numerous to hundreds of companies in an index. The only drawback of investing in a passively managed index is when the pre-selected group of stocks lined up in an index is changed, but that rarely happens.

Personally financing your investments gives you hands on opportunity to monitor whether you are really earning from the returns you have been receiving. Either you selected an active management or passive management of your funds, both needs your close attention of monitoring their progress or else you might just end up with nothing. In these days where people have been hearing about stories of bankruptcy, economic downturns, depression, guess you don't want to be one of them. So invest your money wisely in an institution or index you think could be trusted, stable enough for you to receive your deserved returns and the one that would suit your needs.