What Is An Index Fund
Buying an index fund, or even better, a portfolio of index funds, is a way to own almost every publicly traded stock that is available. Why would you want to do this?
Well, if you think capitalism works, and over time companies will collectively earn profits, the question then becomes, do you try to identify the companies you think will be most profitable (or hire someone to do this for you) or do you find a way to participate in the investment market as a whole, letting capitalism do the work for you? Owning an index fund is a way to participate in the market as a whole.
Owning An Index Fund – Like Owning the NFL
Think of it like this; instead of betting on the team you think will win the Super Bowl this year (and winning big, or losing big), you figure the NFL as a whole will make money as people attend games and buy merchandise.
Although there is not a way to invest in the NFL market as a whole, there is a way to invest in the investment market as a whole; you purchase index mutual funds.
With the right mix of index mutual funds, you can come pretty close to owning all of the stocks that make up the market. Although you won’t know which stocks will do the best from year to year, it won’t matter, as your investments will rise over time as businesses collectively make a profit.
Owning a portfolio of index funds is like owning all the teams in the NFL. There is no need to spend time and money researching each individual team and its players. An actively managed fund, on the other hand, has a staff of people conducting research in an attempt to identify the upcoming Super Bowl winner.
Index Funds Have Lower Costs
Index funds have lower costs as they do not require a large staff, and expensive research. These lower costs, combined with the fact that active strategies are not able to consistently identify the winners in advance, make index funds the best value for most investors.
What About When Index Funds Go Down In Value?
When the stock market goes down, the corresponding index fund will also go down in value. At this time you need to ask, do you think companies are forever doomed to keep losing money, and the market will endlessly go down? Or do you think perhaps companies will reorganize, and once again begin making profits? When that happens the market will once again go up.
It helps to keep in mind that it would be nearly impossible to lose all of your money in an index fund, as that would mean every publicly traded company went out of business at once. If that happens, we all have bigger problems on our hands than our investments.