Howdy Wall St. Willy! Sometime ago we talked about mutual funds and I heard something about an index fund. So, what is an index fund anyway?
An index fund is a mutual fund whose portfolio is built to match the constituents of a stock market index.
What do you mean?
Each index fund is based on a particular stock market index like the S&P 500. It buys all the stocks that make up the index and in the same proportion.
What happens if there is a change in the constituents of the index?
The index fund tracks the index very closely. So, they would change their portfolio to reflect any change in the index.
For e.g., if company A is replaced with company B in the index, the index fund would sell all the stocks of company A that it owned and buy stocks of company B in proportion to what the actual index bought or sold.
Well, what are some advantages of index funds, if there are any?
There are many advantages of index funds. Here are a few of them.
The first one is that the index funds provide a broad market exposure because they invest in all the stocks that make up an index. So, they are usually well diversified. They also have a low portfolio turnover, which means they don’t buy and sell stocks very frequently.
They also have low expense ratios or low overall cost because they don’t have to pay too much money as brokerage thanks to low portfolio turnover and they don’t have to hire research analysts that will do the research to decide which stocks to buy or sell.
Well, what kind of return can you expect from an index fund?
Generally speaking, index funds closely track the index. So, the returns from investing in an index fund will be almost equivalent to the return from the index it tracks.
Who should invest in index funds?
Index funds are less volatile in nature compared to individual stocks and give good return over the long term. So, these should be a core holding of everyone’s portfolios, especially in retirement accounts like an IRA and 401K.
Thank you very much for telling me about an index fund, Wall St. Willy.
You are welcome, Sooper Cooper. Remember, Finance is Your Friend!
Podcast: What are Index Funds
All you need to know about Index Funds: What are Index Funds, what happens if there is a change in the constituents of the stock index, what are the advantages of index funds, what kind of returns can you expect from index funds, who should invest in index funds, and more.
Show notes and transcript at: What are Index Funds?