Wednesday, 8 December 2010

Index funds are the best option in 2011

An index fund is a mutual fund or an exchange traded fund which replicate the movements of an index of particular financial market such as dow jones or sensex. It has a portfolio which tracks and mirrors the components and performance of a market index. Indexes are useful to gauge a nation’s wealth. It also serves as a benchmark for managing mutual funds. Index funds are created using indexing methodologies, which attempt to weight all the securities in the index fund to mirror the target index composition as closely as possible. They also mirror the performance of the index on which they are based.

Index funds are not managed by a particular fund manager. It is called passive fund management. So it has no much expense like other mutual funds. Famous stock market expert Peter Lynch said that, most investors would be better off if they invested in an index fund. Just like famous investment guru Warren Buffett said that index funds are the best way to buy into common stocks. Yes if you buy index funds it is the best way to invest in common stocks. Index funds are based on a theory of efficient market hypothesis (EFH) which states that as stocks are valued with accuracy, it is not possible to beat the market easily.

Advantages of Index funds

The operating expense is very low as compared to other mutual funds. It is managed by passive management method.

The risk is comparatively less than direct investment in stocks. It is less volatile as particular sectors of stock. It mirrors the entire index.

Index funds are outperforming most of the actively managed mutual funds.

Disadvantages of Index funds

100% mirroring the target index is not possible.

The performance of the target index reflects the index fund. So it neither could nor perform well that the target index.

A change in the target index may affect the return of investment adversely.

But index funds are good as those are reflect in the market condition as a whole. If we invest in a particular stock it may be a failure. But in index funds the ups and down of the market index reflect in the funds and the failure of a particular stock does not affect the fund performance. So In the New Year 2011 you can try a portion of your investment in index funds.

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