Tracking the Market with Index Funds
Index funds have become a popular way to invest because of their simplicity, lower fees, and tax efficiency. At the end of 2014, they accounted for 35% of all assets invested in stock mutual funds and exchange-traded funds (ETFs), up from 25% in 2010.1
A market index measures the performance of a specific group of securities. The most broadly referenced index is the Standard & Poor’s 500, which measures the stock performance of approximately 500 large U.S. companies and is generally considered representative of the U.S. stock market as a whole. There are many other indexes representing a wide variety of securities. Keep in mind that the performance of an unmanaged index is not indicative of the performance of any specific security.
You cannot invest directly in any index. However, you can invest in an index fund that attempts to replicate index performance by holding the securities that are tracked by the index. Owning shares of an index fund enables you to participate in the particular segment of the market represented by the index.
For this reason, index funds may provide a convenient way to diversify your portfolio, enabling you to invest in a broad range of strategies and securities through a relatively small number of funds. Diversification does not guarantee a profit or protect against loss; it is a method to help manage investment risk.
Index funds are passively managed, which means they typically don’t engage in frequent trading. They try to match but not outperform a market benchmark. Because of this management style, fees are generally lower than they are for actively managed funds. The lower turnover of securities in an index fund also may generate fewer and smaller capital gain distributions, which could help minimize tax liabilities and improve after-tax performance.
The goals of most index funds are straightforward and relatively easy to understand. However, some investment options may have the word “index” in their names, even though they actually incorporate active investment strategies that aim to outperform broader benchmark indexes. (They are sometimes called “enhanced index funds.”) This is a fundamental difference to keep in mind as it relates to your own investment goals. Investments seeking higher returns typically involve additional risk.
The return and principal value of stocks, mutual funds, and ETFs fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost. Supply and demand for ETF shares may cause them to trade at a premium or a discount relative to the value of the underlying shares.
Mutual funds and ETFs are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.