What is a Market Index Fund?
An index fund is usually an ETF or mutual fund which tracks a specific index. A market index fund tracks a broad market index such as the S&P500 and is considered a passive form of investing versus active investing.
The advantages of investing in index funds are lower expense ratios and instant diversification. With the addition of hundreds of new ETFs, which track specific sectors or sub-sectors of the market, these index funds may be used actively for immediate diversification in a specific slice of the market.
There is a time and a place for index funds within a portfolio. Making index funds a part of your portfolio can provide added diversification and profits to your portfolio when done properly. But investors who exclusively purchase market index funds will almost certainly guarantee a mediocre performance for their portfolio.
Disadvantages of Index Funds
Index funds have two damaging long term flaws. Indexes are inherently skewed toward stocks that have already done well. As a stock rises it becomes a larger and larger percentage of that particular index. The reverse also holds true. Stocks that have performed poorly become a smaller percentage of a particular index. Therefore, when you own an index fund you own a bigger percentage of stocks that have already done well, and less of stocks that may be bargains and have greater potential of doing well in the future.
A broad based market index fund is by definition going to provide market rates of return. The market buy and hold strategy has resulted in a decade with no gains. Taking a loss is bad news, but the real damage is done by losing 10 years of compound earnings. We have no reason to believe the environment will be any different in the current decade.
Do you still believe buy and hold is a wise investment strategy?
Related Reading: What is a “Tactical Asset Allocation Strategy”?
Free Wealth Builder Newsletter
| AAAMP Blog by Ken Faulkenberry | |
|
Ken Faulkenberry earned an MBA from the University of Southern California (USC) Marshall School of Business with an emphasis in investments. Ken has 25 years of investment experience and is dedicated to helping people with self-directed investment management through the Arbor Investment Planner. His asset allocation strategies have an outstanding performance record. |
 |
{ 1 trackback }