Index InvestingIndex investing the easiest way for average investors to outperform most mutual funds on the market. An index is a group of investments that measure how well companies are performing, such as the Dow Jones Industrial Average or the S&P 500. When you invest in an index fund, you can expect similar performance as the market index. Here is an example. By investing in a fund that tracks the S&P 500, you can reasonably expect to get the same returns as the S&P 500. Every investor tries to earn as much as possible, but the annual performance of the S&P over the long term averages about 10-11%, which is fantastic. It is difficult to beat those returns without taking on significant risks. If you do not know about index funds, you may be missing a great opportunity. I'm going to show you how index funds work and why they are popular, so you can decide if they are right for you. Index Funds vs. Actively Managed FundsFunds that try to match an index are different from actively managed mutual funds. Actively managed funds have a professional money manager and try to gain an advantage by trading securities. Most mutual funds work this way, but index use a technique called passive management.This is a completely different approach. Instead of trading actively, they only change their investments when the corresponding index changes. This translates to lower trading costs. Actively managed funds generally have higher expenses than their index counterparts. Many index funds have an expense ratio of about .25%, while the average managed fund has an expense ratio of 1.5%! Actively managed funds normally have sales charges and management fees, while index funds do not. The mutual fund industry relies on the idea that professional managers will always find better investment opportunities than the average investor. The mutual fund industry wants you to believe this so they can earn a commission and fees on your investment. This is simply not true. If there's one lesson to learn from the recent market downturn, it is that professional money managers don't always do a great job. Few mutual fund managers earn returns that make it worth paying their management fees. However, there are mutual fund managers who consistently find great investments and keep management fees low, but they are harder to find. That is one reason why I post the best ones that I find on this site. Actively managed funds are fine if they are thrifty and produce great long-term returns, but this is not the majority of mutual funds. Index funds are popular because they have fewer obstacles than most mutual funds and provide a few key advantages to average investors. Benefits of Index InvestingIt doesn't take a rocket scientist to figure out that average returns minus investment fees will give you below average returns. Even a fifth-grader can do that kind of math.Index funds have a few major advantages: It is hard to go wrong with index investing. Since most stock funds do not outperform the S&P 500, you can outperform most other investors simply by investing in an index fund. How To Evaluate Index FundsEvaluating performance for index funds is very simple; you want to consider how much they will cost you, and how closely they match the index.You should not pay investment fees or sales charges to invest. This will save you money from day one. If you don't pay a sales charge, you will already be ahead of all the other investors that pay them (trust me, a lot of investors do). Make sure the annual costs are low for your fund by choosing one with a very low expense ratio (lower than .5%). Some funds also do a better job of matching indexes more closely. The best way to measure this is a fund's beta. You want a measurement of exactly 1. If the beta is too much higher or lower than 1, you may get unexpected returns. Index funds also carry the same risks as any other mutual fund. Funds that match a stock index will have the same risks as most stock funds. Funds that match a bond index will have the same risks as most bond funds. You don't need to take any unnecessary risks to invest in an index mutual fund and earn the same returns as the market average. You will also need to decide which index to match. The S&P 500, Dow Jones Industrial Average, and NASDAQ are the three major stock indexes, but there are many other indexes to invest in. Is Index Investing Right For You?Index investing is very simple and cost-efficient, which can lower your investment costs and give you an easy advantage over most mutual fund investors (especially the ones paying a sales charge).Conservative investors usually invest in index funds because of their low costs and easy-to-track performance. You can't turn on the new these days without hearing what the stock market closed at. The major market indexes have also been around around for a long time, so investors are more familiar with them. Index investing will provide a good foundation for your portfolio and give you a benchmark to measure the rest of your investments against. After all, they do try to match the performance of market measurements. To start out successfully as an investor, you should avoid sales charges, keep your fees low, and invest in funds with low volatility. Index funds do all of these things while outperforming most mutual funds on the market.
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