Why You Should Invest in an Index Fund

There are quite a lot of financial assets people invest in nowadays, from common stocks to real estate investment trusts. Index funds is another one of these investable assets you can allocate your capital to. But before investing in these funds, there are several key questions you need to ask and have answered. For instance, what exactly are index funds and what features do they have that make them a worthwhile investment?

Index Fund in a Nutshell

Majority of mutual funds are operated by managers who pick stocks and other investment vehicles that have potential to earn above-average returns. On the other hand, index funds aim to mirror the results of a specific fund, rather than beat it. Index funds were created to enable investors to participate in the financial markets without subsequently risking the level every time the participant beats returns, a theory experts coined as the Efficient Market Hypothesis.

Advantages of an Index Fund

Simpler Tracking. Index funds are used to track the performance of different sectors including the U.S. stock market, international stock markets, foreign bond markets, and simply anything else an investor wishes to trade. Now, imagine trying to track and buy thousands of these investment vehicles. It won't just be a costly endeavor due to the commission fees involved, but it can be nerve-racking as well due to the number of assets to keep track of.

Lower Cost. Since index funds are characteristically passive in its investing approach, commission fees are generally lower. In addition, According to a study, the average dollar allocated to the stock market incurs a 1.5 percent in investment expenses while only earning a net ROI of 7.5 percent. For index funds, however, every 1 dollar you invest has a theoretical ROI of 8.8 percent return with a 0.2 percent expense.

Tips When Investing in Index Funds

Choose a fund wisely. Keep in mind that not all index funds are low-cost. Some will charge ridiculously high expense-reward ratios that make the investment more of a liability over time. It's best to look for the fund's expense ratio and compare it to that of others. Furthermore, allocate only a portion of your investable capital into index funds. Diversification is key to reducing risk and concurrently improving rewards.

Index funds are only profitable if the investor buying and selling it exercises discipline and technical prowess. With all else being equal, however, index funds are definitely a bargain you should look into.

David Milberg is an experienced investment banker who hails from NYC.