What is an index fund?
Stock markets like to group loads of their more important shares together into an index – like the FTSE 100 in London or the Dow Jones in New York. This index then tells us how this bundle of shares is trading.
An index fund is a sort of mutual fund that bases its portfolio on the securities that make up a particular index and their weighting in that index.
Where have you heard about index funds?
You may well have seen them advertised as a way of investing in the stock market that is (a) cheap and (b) safe.
Cheap, because the shares pick themselves, so no need to pay an expensive professional fund manager, safe, because the fund will always do as well as the index. Though, of course, the index can go down as well as up.
What you need to know about index funds...
They’re sometimes called tracker funds. Quite simply because they track whichever index they’re based upon (being made up of the same shares as the index and in the same proportions).
But while this means they can never do any worse than the index as a whole – neither can they do any better.
So the big question is then: are they any good?
In favour of the index funds is the fact that, at any one time, many (if not most) other funds fail to outperform the market, delivering no better returns than an index fund but with the managers’ salaries to pay as well.
But in that case, why doesn’t everyone buy an index fund? Well, the best fund managers will tend to outperform the market and some investors will always want to beat the average.
Which is probably a good thing, because if everyone – professional investors included – bought an index fund, there wouldn’t be any movements to track!