WHAT IS AN INDEX FUND? An index fund is a mutual fund that duplicates as closely as possible the performance of a stock market index or bond market index that it tracks. A few examples of indices are: S&P 500, Wilshire 5000, Russell 2000 and Dow Jones Industrial Average.
1) MUCH LOWER FEES AND EXPENSES. Who wouldn’t want to save money on their investments? Because index mutual funds are passively managed, they charge lower fees resulting in some of the lowest expense ratios in the mutual fund market. Vanguard, one of the leading index fund providers, has an average expense ratio of 0.27% versus the market average for all mutual funds of 1.50%!
2) BETTER PERFORMANCE. Most non-index funds do not outperform their relative index. Only 35% of active fund managers beat their index [according to Ibbotson Associates]. Why not go directly to the index?
3) TAX EFFICIENT. For your taxable investments, you could have much lower capital gains tax due to less stock turnover – which will save you money on your taxes. Because the mutual fund is mirroring the investments in the index, the manager is trading much less – which means fewer capital gains or losses. Mutual funds with a high turnover ratio are hit with higher capital gains taxes in an up market, even if the investor didn’t sell her/his mutual fund shares. For people that have a high investment income tax bill, this is especially important.
4) LESS STRESS. Index funds are usually easier to monitor and check performance. For example, if you invest in an S&P 500 index fund, you can easily check the Year-to-Date performance each week by just reading the front page of the New York Times Data Bank section on Sunday. Much easier than reading your statements, wouldn’t you agree?
5) EASIER TO FIX YOUR ASSET ALLOCATION. You just finished your financial checkup and found that you are lacking small-cap value stocks. The easiest way to remedy this, assuming other characteristics meet your standards is to find an index fund of small-cap value stocks. A great website for index funds: www.indexfunds.com.
©Copyright 2007 Down to Earth Finance, LLC