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What is an Index Fund? A Definitive Guide


When faced with volatility in the financial markets, your first defence against the inevitable is having a well-balanced and diversified portfolio. Diversification of your portfolio can be done in many ways, and one way is to use index funds which offer instant diversification through owning a wide swath of companies in one instrument. Index funds can give you low-cost access to diversified investment. In this article, we explore what index funds are, how they work and some examples you may consider.  

What is an index fund?

An index fund is a type of mutual fund or exchange-traded fund (ETF) that keeps track of a financial market index. A market index, in this context, tracks the performance of a basket of assets representing one sector of the stock market or an economy. While you cannot invest in a market index directly, you can use an index fund to enjoy indirect exposure to the basket of products. 

Some common examples of index funds include:

How Index Funds Work

By “indexing”, managers create a passive way of managing funds. A fund manager develops a portfolio that contains the securities found in a certain index, rather than actively selecting stocks. The manager now no longer has to decide which assets to invest in or plan when to purchase and sell them. The theory behind Index funds is that, by closely matching the profile of the overall stock market or that specific index, the fund will be able to match its performance. 

For every financial market that exists, there can be an index for it and a matching index fund. For instance, many popular indexes in the U.S. track the S&P 500. 

Pros and cons of Index Funds 

If you’re thinking about trading index funds, here are some advantages and disadvantages of index funds for you to consider: 

Advantages of index funds 

Disadvantages of index funds 

How to buy index funds? 

To buy an index fund, you’ll first need to find an index fund you’re keen to buy. Much like purchasing an ETF, you can buy index funds directly from a mutual fund company (such as Fidelity, BlackRock, Franklin Templeton and more), or via a brokerage.

Top 5 Index Funds

With so many index funds around, how do you find one that fits your portfolio? To help with your research, here are some of the popular index funds you can check out today. 

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