Buying Index Tracking Stocks
Index tracking stocks can be a great long-term investment for individuals who want to be invested in the stock market without having to constantly watch their investment and do lots of research. Since the average mutual fund can't seem to beat the S&P 500 Index on a consistent basis, index tracking stocks can take a lot of the guesswork out of “beating The Street.”The two most common index tracking stocks are Spyders (AMEX:SPY) and Diamonds (AMEX:DIA). Spyders track the S&P 500 Index. Diamonds track the Dow Jones Industrial Average (DJIA). The share price of a Spyder represents 1/10 of the overall S&P 500 Index. In other words, if the S&P 500 Index is at 1,000 on a given day, the corresponding share price of a Spyder will be $100. Therefore, for every 10 points the S&P 500 increases or decreases, the price of a Spyder share will increase or decrease by $1.The share price of a Diamond represents 1/100 of the DJIA. In other words, if the DJIA is at 10,000 on a given day, the corresponding share price of a Diamond will be $100. Therefore, for every 100 points the DJIA increases or decreases, the price of a Diamond share will increase or decrease by $1.
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Instructions
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Decide which index tracking stock is right for your portfolio. Diamonds represent 30 large industrial companies. Spyders represent 500 of the top companies traded on U.S. exchanges. While the DJIA is the benchmark by which the American market is commonly measured, the S&P inherently provides greater diversification by indexing a much larger cross-section of the overall market.
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Buy one or both index tracking stocks. This is as easy as buying any other stock. As long as you have an open brokerage account and the necessary funds available, you can use a market order or a limit order to buy either stock.
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Invest systematically. Index tracking stocks lend themselves best to systematic investment. Unless you are dealing with huge amounts of capital, they don't make good sense as a trading vehicle because their volatility is muted by virtue of the fact that they represent 1/10 or 1/100 of their underlying index, respectively. It is better to invest a set amount on a weekly, bi-weekly or monthly basis, and take advantage of dollar cost averaging. This has the effect of keeping your cost basis low when the market is rising while enabling you to average your basis lower when the market falls.
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Invest for the long term. Index tracking stocks work best when they are given several years to appreciate. Just like the overall market trends upward even though we have occasional corrections, your index tracking stocks will do the same.
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Get wild and crazy. Even though we have concentrated on the two most popular index tracking stocks in this article, they are by no means the only index tracking stocks available. There are index tracking stocks that represent both the long side and the short side of every conceivable sector. Currently, over 800 index tracking stocks are actively traded.
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