When you start out investing, one of the common recommendations is to invest in index funds. There are plenty of experts and personal finance bloggers alike who think that index funds make great options when it comes to the beginning investor. Even a pro can benefit from index funds.
Here are 3 reasons why index funds are so popular:
1. Easy to Invest In
Various online discount brokers have made it very easy to invest in index funds. These funds track a specific index, such as the Dow Jones Industrial Average, the MSCI, the S&P 500, or the Russell 2000. There are also index funds that track bond indexes, and other indexes.
Index funds are fairly easy to understand, and they are easy to invest in. They follow the fortunes of the index being tracked, so there isn’t the difficulty that somes with stock picking. Index funds can be held in tax-advantaged retirement accounts, and many people like them because the market goes up over time. Invest in the market (you can invest in all-market index funds), and the assumption is that you can’t lose over the long haul (although there is the risk, and a first time for everything).
2. Low Cost
Another advantage that index funds boast is that they are low cost. Index funds don’t have the same high administrative fees that managed funds have. While you might pay 1.5% or 2% or more for each year for a managed fund, there are many index funds that charge less than 1% a year. Additionally, many index funds don’t come with sales loads.
With index funds, you have much lower fees. When you consider that that fees are one of the things that erodes your returns and overall wealth, index funds suddenly look much better, since they don’t cost you nearly as much over time.
3. Instant Diversity
Index funds also provide a measure of diversity… assuming that you choose wisely. Instead of trying to buy individual stocks to build a diverse portfolio, you can buy one index fund and get exposure to different companies, across different sectors and industries in some cases. This is a great advantage. On top of that, it’s easy to further diversify by choosing different index funds from different parts of the world, or that provide you with access to different asset classes.
Index funds can provide you with a little bit of diversity without a doing a lot of work. And, of course, you have some of your risk spread out, since if a few investments on the index drop, it probably won’t overwhelm the total performance of the index.
Investing in index funds can be a way to build a portfolio without the need for a lot of expertise (it still helps to know the basics, though), and without a large expense. Because index funds are easy to buy, and because they provide many with a sense of security about the future, they are quite popular. Before you invest, though, it’s important to do some research. Make sure that index funds are right for you and your investment situation.