Index Funds are mutual funds that keep a portfolio of securities (stocks and bonds) that matches or mirrors a broad based index Indexes such as the S&P 500. Many investors believe they cannot “beat” the stock market consistently, so they would be content if they could match the market or a particular segment of the market, minus the fund’s expenses. Index Funds can only be traded at the end of the trading market day.
Types of Funds
There are over 1,000 Index funds such as:
- Broad Based Market Indexes: These track the large markets such as: S&P 500, Dow Jones Wilshire 5000, Russell 2000 etc.
- Sector Indexes: Technology, Energy, Real Estate etc.
- Sector Size Indexes: Large Cap, Small Cap, Mid-Cap etc.
- Foreign/International Index Funds: China, India, South America, etc.
The cost of managing an Index Fund, which is considered a "passive" managed fund, is cheaper than the cost of running an "actively" managed portfolio where an individual portfolio manager "selects" individual stocks to include in the portfolio. Index Funds only try to duplicate the performance of the benchmark index (not beat it), so they either purchase all the securities or a representative sample of them, in the index or sector, based on the fund criteria (specified in their prospectus). No specific "selection" process takes place therefore management fees, brokerage fees, commissions and other expenses are lower.
No investment is risk free. If you believe, for example, the market is going to go up, especially large companies you might invest in an S&P 500 Index Fund. However, if you guessed wrong and the S&P 500 goes down by 5%, your index fund will follow suit and also go down 5%, since it is designed to copy the results of the S&P 500. Also by only being able to trade at the end of the trading market day reduces your ability to reach financial information.