What Is An “Index Fund”?
Last year, nearly $700 billion was poured into index funds across all asset classes. What does this mean, and why is this type of fund rising in popularity?
What is an Index Fund?
“You can think of an index fund as a basket of stocks with hundreds or thousands of different ones inside”
Instead of doing the research (or paying a firm or individual) to invest in stocks one by one, Index Funds offer a simple, relatively low-cost way to invest in a wide swath of companies.
How are they used?
The most well known Index Funds track the S&P 500, a stock market index based on 500 large companies that have common stock listed on NASDAQ or the New York Stock Exchange.
They are often used as an investment vehicle for an individual person’s retirement, because their characteristics lend themselves best to long-term planning.
- The earnings are not tied to an individual company, so the fund value doesn’t rise or fall based on the whims of impatient shareholders, failed product releases, or hostile takeovers.
- The fees are low because the funds don’t need nearly as many analysts to research daily or weekly trends, so more of the earnings go to the individual investors as opposed to fees that pay for the overhead of the fund.
Who Created Index Funds?
The founder of the Vanguard Company, Jack Bogle, took insights from three academic papers, and melded them to create the first well known index fund. At the time it was widely known as “Bogle’s Folly”, and was even viewed as “Un-American” as it was in such stark opposition to the hyper-active traders of the 1960’s and 70’s. He initially raised only 11 milion, less than one-tenth of what he intended to start the fund, and faced widespread pushback.
However, in the year 2000 Bogle’s Vanguard 500 Index Fund surpassed over 100 billion in assets, and spawned a number of copycats and derivative funds that took his initial thesis and applied it to different types of investments.
His boldness in creating this new vehicle, has made investing more accessible and drastically lowered fees, especially for non-professional investors.
The Oracle of Omaha, famed value-investor Warren Buffett specifically recommends Index Funds as a way to boost retirement savings. “Consistently buy an S&P 500 low-cost index fund,” he told CNBC’s On The Money. “I think it’s the thing that makes the most sense practically all of the time.”
There are a number of funds with low minimums that are accessible to the overwhelming majority of people looking to invest, some start at as low as $100.
As with any type of investment, read about the pros and cons, review multiple viewpoints, and do your own research before coming to an informed decision.
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