You found good ways to make money and stick with your budget, so now it’s time to invest the cash you earned. Things like cryptocurrency, meme stocks, or Elon Musk’s latest venture could sound enticing and cool, but they also may not be the most sound investments for you. It might be time to consider index funds.
While index stocks may not be buzz-worthy, they could be a good thing if you want to diversify your portfolio. Here are some things to consider when trying to decide if index funds are sexy (and smart) enough for you to invest your money in them.
What are index funds?
An index fund is a type of mutual fund or exchange-traded fund that is designed specifically to track a particular index, such as the S&P; 500, Nasdaq, or the Dow Jones Industrial Average. Instead of having a basket of stocks that a portfolio manager actively picks and chooses, an index fund is simply a group of stocks that reflect the actual index. That means they’re designed with the goal of replicating the returns of the index they’re modeled after.
Index funds are smart if you are trying to diversify your portfolio or invest in the stock market as part of your retirement accounts. They also don’t need to be actively managed by a fund manager the way other funds do, so you might pay less in fees.
So what are some more advantages to having index funds as part of your investment plan?
They diversify your portfolio
Instead of investing in one stock here or there, an index fund typically contains a diverse group of different stocks. The S&P; 500, for example, has companies in health care, real estate, information technology, consumer products, and financial institutions. It might be difficult for the average investor to create that kind of diversity and effectively manage the stocks in that portfolio.
An index fund could give you immediate diversity with a variety of stocks covering different types of business sectors. In fact, at last year’s annual Berkshire Hathaway meeting, investing legend Warren Buffett recommended investors consider index funds due to their diversity.
The fees are often low
In general, index funds are not actively managed. That means there’s no manager sitting at a desk actively trading stocks or moving investments in and out of a fund. A manager working like that may mean you have high fees because you’re paying someone to constantly manage the fund.
Index funds simply track the index you’ve decided to invest in. An S&P; 500 index fund tracks the Standard and Poor's index of the 500 largest U.S. companies, which have already been picked out to be a part of the market’s index. There’s no need for a fund manager to stay on top of different investment trends or see which stocks are hot or not. And because an index fund doesn’t need such an involved approach, that could translate to less money you have to spend on fees.
The goal is steady growth
If you look at the historical data from these indexes, you’ll see steady growth over the years. Since the inception of the S&P; 500 in 1957, the index has had an average annualized return of 10.67%. Some years may be better than others, of course, but for some long-term investors, a return like that could be good growth for their portfolio.
This could be especially true for those who have an index fund as part of a retirement portfolio where you may be aiming for steady growth like that for years (or even decades) before you’re ready to retire.
Taxes could be lower
It’s the consistent buying and selling that could generate taxes on capital gains, leaving you with a decent sized tax bill at the end of the year depending on the changes in market positions made to your portfolio. With index funds, the stocks are set based on the index, which will likely see only a few changes over the course of a year. That could mean more money in your pocket with less spent in taxes.
Volatility isn’t a top concern
Volatility can be an issue for investors with positions in certain stocks or specific mutual funds. Good news for a particular sector could be a boon, if you own a mutual fund invested there. But bad news about a company could send that stock in your portfolio plummeting.
Because of the more diverse nature of an index fund, the peaks and valleys of a volatile stock market might smooth out more quickly than other types of investments. That can’t be said for owning stocks in specific companies that may have volatile growth — or even no growth — between when you buy the stock and when you’re ready to sell it..
Investing is easy
Learning how to invest in index funds is likely less complicated than you think. Once you've decided which funds you are interested in, you have different avenues to make that investment. You can buy online through mutual fund providers such as Fidelity or Vanguard.
Using one of the best investment apps may be a simple option for getting started. Or choose a financial advisor if you prefer having someone you can call and speak with directly.
Figuring out how to invest your money in the stock market can sometimes be daunting, which is why index funds might be the right choice for you. They could give you a steady return without the need to actively manage specific stocks and funds in your portfolio. Also, they may save you money in taxes or fees, compared to constantly buying and selling stocks.
Unlike some volatile stocks and funds, the level return that index funds might deliver over time will hopefully allow you to worry less about the daily highs and lows of the market. As a bonus, maybe it will help you relax a bit more during retirement — and that is certainly a sexy prospect in our book.
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