What is an Index Fund?

 

There are so many options available for saving and investing when it comes to retirement planning, it could make your head spin. Among all the various options, it is essential to select the investment option that will help you achieve your retirement savings goal, and for that reason, one of the best and simplest options is an index fund.

Index funds are a great option when saving for retirement. After this article, you will understand what an index fund is and how it works.

Index funds are a type of passive investment. They are different than actively managed funds. With an index fund, the investor (or fund manager) does not have to worry about picking individual stocks & securities. Rather, the fund itself tracks an overall index or sector. For example, one of the most popular index funds tracks the S&P 500. Basically, whatever the S&P 500 does on an annual basis, the fund mimics. So, there’s no need to worry about the 500 individual companies inside the index – you just participate passively in whatever gains or losses the index had on an annual basis.

The reason why we recommend you start investing your retirement money in index funds is that this method of investment is simple, and simplicity, coupled with consistently, is one of the best ways to get ahead in retirement. Index fund investing avoids the stress of researching different stocks & bonds, and then guessing which ones will be the winners. Since you own the entire index, you get all the winners for that year.

Investing in index funds is not just simple, it’s also less risky. Let’s examine how it’s less risky. In regard to stock market investing, when you invest your money in a particular company's stock, you are taking on a high degree of risk since the performance of your money is tied to the performance of just that one company. By investing the full amount in a single company, your investment loses diversity, and if the company does not perform well in the future, or even goes bankrupt, you bear all the losses.

With index funds, this is not the case. By investing your retirement savings in index funds, by design, the investment will automatically get diversified.

For example, if you invested a $5,000 lump sum into a Dow Jones 30 index fund, your entire amount invested will be divided into the stocks of those 30 different companies. So, if any of those companies do not perform well, it will be balanced with the performance of the other companies that are doing well. Because of this, the amount invested in index funds will have a comparatively lower risk factor.

Apart from this, it will also save you time and will reduce your investment expenses, as index funds almost always have lower expense ratios compared to actively managed mutual funds. This is because with index funds, the fund managers do not have to spend their time researching, finding the right stocks, and investing in them. The fund is simply tracking a basket of assets, so not having to “dive deep” reduces the expense ratio.

Ironically, sometimes index funds fair far better than funds with active managers. The reason behind this is that the index fund guarantees to give you the return of an asset class, as a whole. Whereas picking individual stocks runs the risk of picking some losers and missing out on the winners.

So, if you want one way to maximize your wealth in order to have a stress-free DeSoto retirement, you can consider investing in index funds. Though the market may fluctuate in the short term when you invest your money, when you invest in the right index funds for the long-term, it can generate great returns for your retirement portfolio.