Investments can be a tricky, murky and expensive necessity to deal with if you are not a finance professional.
To be fair, it is tricky for them too but if one was to take a simpler approach to investing and still expect to beat inflation, staying invested in index funds would be it.
“When you look at the results on an after-fee, after-tax basis, over reasonably long periods, there’s almost no chance that you end up beating the index fund.” – David Swenson, Renowned American Investor
What is an index fund?
Before we understand index funds, it is necessary to understand what indexes are.
An index is simply a collection of different securities in the market.
Since these provide ample diversification in terms of sectors and industries, representing the broader market, indexes provide for high returns while providing some risk mitigation.
Index funds are essentially mutual funds that mimic these indexes, and aim to provide similar rates of returns to investors as the broader market.
And why you should think about investing in them
Diversification
Index funds cover a large basket of stocks from across industries and thus allow you to have a diversified portfolio without having to pick individual stocks.
They, too, are not immune to market fluctuations but a large fall in a specific sector is unlikely to completely pull down your investment when it comes to index funds.
Lower Costs
When you invest in mutual funds, the fund takes a charge for managing and investing your money. There are fund managers and entire teams involved in the running of mutual funds, and that requires capital.
As index funds are tracking the market, their expense ratios or the cost of commissions and account management are lower, which then get passed on to the investors (you).
Accessibility
Unlike other financial instruments, where you have to spend a lot of time actively doing research and keeping track of multiple things, investing in index funds is a simple approach where you are investing in the future performance of the broader market.
They are also readily accessible with almost every investment platform now having multiple index mutual funds on offer, giving passive investors a way to stay invested and earn inflation-beating returns.
And no, they do require managing
A common misconception when it comes to index funds is that they don’t need managing, which is incorrect as the market is constantly changing. Indexes go through their ups and downs, with some stocks gaining more weightage and some others losing their spot on the index.
Fund managers have to keep a close eye and rebalance periodically so your returns are as close to the index returns.