Many of us are novice investors and know very little of the ins and outs of Wall Street. I am certainly no Warren Buffett. In the past 10 or 15 years index funds have become popular investment vehicles to create broader diversification. In order to determine if you should invest in index funds, I think it is important to examine a few areas: defining what an index fund is, the benefits of having an index fund and what potential downsides could occur.
An index fund is a collection of investments that tries to capture a specific market standard. For example, you can buy an index fund that mimics a particular industry (think utilities, oil and gas, etc.) or follows the overall stock market. The Vanguard Energy Fund Investor Shares or the Vanguard Total Stock Market Index Fund are some of the most popular investment vehicles in this area. I personally would not invest in the first one because I feel that it is too risky. I try to avoid taking too much risk when it comes to my money. Energy stocks have truly been on a roller coaster. That does not mean the Vanguard Energy fund is bad, but not for me at this moment.
Index funds are an easy way to invest. All a person really needs is a broad stock market fund and a bond fund. You really do not have to research each individual company or do much reallocation of funds. Index funds are truly a passive way of investing. So, if you do not have the time to actively manage your investment, or know very little of stocks, this is the way to go when starting out.
One of the major downsides to index fund investing is you do not always witness astronomical returns. A person is simply trying to keep up with the overall stock market. There is really no flexibility with these funds and stock indexes normally only provide average results. An individual is not going to get rich quick with index funds, but over a longer period of time, I think people can build wealth. You really just have to know upfront that massive gains over night are not going to happen. Index funds are a safer way of investing.
When I first started investing I chose individual stocks and I have always enjoyed doing the research on picking them. However, I have started paying closer attention to index funds and I have my Roth IRA setup in an index fund. With more financial education, I have become more supportive of index funds. I still love investing in individual stocks, but I do see the benefits of these types of funds. Jim Cramer from the popular television program, Mad Money, argues a person should put their first $10,000 in an index fund before venturing out with individual stock picking. I believe this is smart advice.
Over the years, there is one saying that has remained with me: “diversification is your only free lunch.” It does not cost anything to be diversified and the benefits of it are wonderful. I guess I just strongly believe when it comes to your hard earned money, a person should always play it safe and invest responsibly. You should never keep all your eggs in one basket. An investor might be able to take more risk when younger, but be mindful of what you are really trying to do; make money! Always think long-term. Just food for thought.
Do you have an index fund? Would you ever consider having one? Remember you should never solely rely on your retirement plan at work. Multiple streams of income is always the way to go if financially possible.