What Is an Index Mutual Fund?
Mutual funds are investment vehicles that spread the risk by pooling investor's money together who have similar investment objectives and investing in several hundred companies that meet that objective. There is an entire spectrum of mutual funds ranging from extremely conservative to highly aggressive. Since these investments use the Indexes as a means to measure the success of funds, many companies have created Index Funds that match the companies that are listed in the Index they refer to.
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What are Indexes?
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An Index in the investment world looks at changes in specified investment types. These indexes and others are basically a way to snapshot what an entire group of securities will be doing. By studying an index, investors can determine economic trends and how industries will perform. Some indexes reflect large-cap stocks while others focus on mid to small capitalization stocks. Indexes have been created for just about every area of investment objective as a means of judging how managers are doing with their selected sector of investment. Simply put, they are the benchmark. The Dow Jones Industrial is the most popular Index in the world consisting of the 30 largest publicly traded companies. The NASDAQ and S&P 500 are other Indexes popularly followed in the United States and abroad.
What Determines the Index?
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Many indexes are weighted, meaning they are only using the price of the stock of each underlying company to determine the overall value of the Index. The Dow Jones is an example of this. Other ways to define an index can be market-value or capitalization-weighted. These methods look at more than the stock price to determine the value of the Index considering factors such as company size and overall market capitalization. Attributed weight looks at the factors of growth and a value score along with stock price.
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The Index Fund
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By investing in an index fund, investors remove the work of managing the fund to try to beat the index. For many investors, they are more comfortable with the fluctuations of the index fund knowing that what they see on the news has a direct correlation to what they see on their statements. They have become increasingly popular as investors have become more savvy to the real return of other investments.
Real Returns
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One of the major problems investors have with mutual funds is fees. There are operating and management fees that can eat away at the actual return the fund is getting. By investing in Index Funds, much less in management is required thus lowering the fees associated with the fund. It is a less expensive option. As a result, index funds may still yield a higher return compared to funds that seemingly did better but had high management fees and high turnover of stocks within that create tax consequences for investors not in tax-deferred vehicles.
Criticism for Index Funds
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There are two main criticisms for the investment in Index Mutual Funds. The first is one of management. While some see this as a benefit leading to less fees, others state that good managers use the Index with their additional expertise to make decisions that far exceed the Index and any associated fees. The other major criticism is that there are so many ways that Indexes are defined as discussed in Section 2, that investors may not understand how the stocks within the Index are affecting the return.
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