How to Understand Index Funds

Why all the excitement about index funds? They charge low fees and their performance is consistent with the market.

Difficulty: Easy

Instructions

1. Understand that mutual-fund companies generally invest in a mix of stocks, then professionally manage the portolio. The fund operates on money provided by individual investors.

2. Know that mutual-fund company charges investors fees for managing the portfolio, even though many funds underperform the market over time.

3. Gauge the performance of the market by studying market indexes such as the Russell 2000 or the Standard & Poor's 500. These indexes show the combined performance of hundreds of stocks over time.

4. Know that an index fund is a mutual fund that invests in stock that mirror particular index such as the S&P 500 or Russell 2000. The funds are designed to perform as the market performs.

5. Gather information about various stock indexes. The Russell 2000 consists of small-cap stocks; the S&P 500 consists of large-cap stocks. The Nasdaq also has several indexes.

6. Find out which mutual-fund companies offer index funds. Magazines such as Money, Kiplinger's and Smart Money regularly run lists of mutual-fund companies.

7. Compare how much the companies charge in management fees for their index funds.

8. Remember that management fees for an index fund should be low. The company has no tough investment decisions to make.

Tips & Warnings

• Remember that an index fund reflects the market, so you won't be able to compare it to the market when you are shopping for a fund.
• Most newspapers and financial Websites report on the daily performance of key indexes such as the S&P 500, Dow Jones Industrial Average (or the Dow) and Russell 2000.
• Steer clear of index funds that charge high management fees.