Things You Need To Know Before Investing in Index Funds
What are Index Funds?
Before investing in Index Funds you need to first know what they are. They are a type of Exchange-traded fund or Mutual fund that tries to track the returns of a market index (which measures the performance of a “basket” of securities like stocks or bonds). Examples of the market indexes that Index Funds may seek to track are The S&P 500 Index, the Russell 2000 Index, and the Wilshire 5000 Total Market Index
When investing in Index Funds different approaches may be taken when tracking the market index. Some invest in all the securities included in the market index while others only invest in a small amount included in a market index. To help achieve their investment goal some index funds may even use derivatives such as options or futures.
Investing in Index Funds, the goal is not to out perform the market by making frequent purchases and sales, but rather to maximize returns over the long run by not buying and selling very securities often.
Find Out What The Index Funds Fees Are.
Whether you’re investing in Index funds through a 401(k), IRA, or taxable investment account, you’ll want to opt for Index Funds with an expense ratio below 1% — ideally around 0.5% or lower. For example, if you invest in an index fund with a 0.5% expense ratio, the brokerage will take $5 for every $1,000 of your total account balance annually.
Some Of The Risks Associated With Index Funds.
Like any investment, investing in Index Funds involve a certain degree of risk. Some of them are as follows:
- An Index Fund may not perfectly track its index
- An Index Fund may have less flexibility than a non-index fund to react to price declines in the securities in the index.
- An Index Fund may underperform its index because of fees and expenses, trading costs, and tracking error.
Do Your Research
Before investing in index funds, you should carefully read all of the fund’s available information, the fund’s prospectus, and most recent shareholder report. In addition, funds disclose their portfolio holdings quarterly in Form N-Q and shareholder reports. You can typically get this information from the fund’s website or your financial professional, as well as on EDGAR.