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Investing in Index Funds: A Beginner’s Guide to How it Works

There are numerous investment funds that you can participate in, with each one catering to your different needs. One of these investment funds is called index funds.

Index funds have recently grown in popularity as more investors now choose to invest in it. Studies show that more than $1 of every $5 investment in the equity markets go straight to an index fund.

Most of the people who do decide to invest in index funds are those who are on a tighter budget. One of the greatest advantages that investing in an index fund offers are the low fees. You wouldn’t need big capital to begin investing and won’t even have to worry about finding assets to invest in.

Investing in Index Funds

What is an Index Fund?

An index fund is a type of mutual fund. What sets it apart is that it has a portfolio made specifically to match or track the components of a market index. Some of the most popular index funds track the Standard & Poor’s 500 Index (S&P 500).

There are also other funds that track different indices. These include the MSCI EAFE which has foreign stock in Europe, Australasia, Far East, the Russell 2000 which contains small companies, and the DJ Wilshire 5000 which is an index for the total stock market.

An index mutual fund is meant to deliver broad market exposure, low operating expenses, and low portfolio turnover. Also, this kind of fund follows a specific set of rules or standards. These are meant to stay in place no matter what state the market might be in.

Investing in index funds asks for you to be a patient investor. When your fund experiences good times, there are no heavy inflows. But when your fund goes through bad times, you wouldn’t have to worry about heavy outflows of cash either.

People in the investing world consider index funds as “easy and boring”. This is mainly the reason why people who wish to have their investments be filled with excitement and challenge consider different investment funds to get into.

But, if you prioritize above-average gains with little or no work, then index funds might be the one for you.

index fund investing concept

Pros and Cons

Every investment you find will have its own pros and cons. You should now determine whether the benefits you reap are enough for you to invest in it despite its disadvantages.


Low Fees

The managers of an index fund no longer have to find stocks to invest in. Meaning you only have to pay their management expertise. This makes it possible for you to begin investing without using huge amounts of capital.

The difference of capital between an actively managed fund and index fund is more than two percentage points of cash. This means that shareholders are robbed of at least one-tenth of a percent of their return. The amount might be small if you look at it now, but in the course of an investment lifetime, the difference can reach $150,000.

No Fund Manager Bias

With other investment funds, there is always the chance that your fund manager might end up some underperforming stocks. The way that the fund performs can also change once the manager leaves. But index funds remove this risk by only investing in assets that represent your index.

Additionally, as was previously stated, fees paid to index fund managers are lower when compared to other actively managed funds.

Learn more about what can happen when you buy stocks without a broker.

Low Risk

When you invest your capital in an index fund, you wouldn’t have to worry too much about losses. They are also diversified seeing as it represents many various sectors within an index. This means that you’ll be protected from massive losses.

Index funds might not have too much excitement but it’s reliable. This kind of fund promises steady flow of income, no matter where the market might sway.

Everything in One Place

Investing in an index fund can actually help you diversify your portfolio. This is a much easier way of diversification than investing in individual stocks. Even professionals have a bit of a hard time when it comes to putting together the best portfolio. But when you choose an index fund, you already get exposed to a wide variety of stocks which represents various industries.

Owning shares of an index fund also means that you do about as well or poorly as everyone else in the stock market.

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No Control

You should consider that when you choose to invest in an index fund, it means that you’ll be supporting all the companies in that index. So, if you have any personal feuds with a company but it’s in your index, you have to stay involved. You wouldn’t be able find an exit route that will allow you to remove your money from the company.

There are also the companies that you like, such as a favorite service provider, but are not part of the index. Even if you wish to be involved in the company in some way, you won’t be able to achieve this through the index fund. There can be specific companies that you wish to avoid or support but know that your control will be limited.

Index fund managers also follow certain policies and strategies which limits their flexibility. This is for the fund to perform exactly the same way as the index does.

Any decision made about the fund must be in-line with the index returns. This means that there are normally limited options that an index fund manager can do to limit the losses if the index is strongly declining.

No Huge Gains

If for you, the thought of investing is synonymous to making huge gains, then you should consider other options. Your money gets spread out to numerous stocks in the index. This means that even if one stock does great, you wouldn’t receive a huge spike in your index fund value.

You will have to settle with a slow but steady earning pace instead.

Read about the opposite states of the stock market in Digging Deep into Bull and Bear Markets.

Stress is Unavoidable

You might have thought that by investing in index funds, you can escape the stress that accompanies investing. If you did have that thought, then you have to reconsider.

When you invest, you might end up plagued with constant worry and stress especially when the market is on the verge of a crash. Such situations can end up stealing your precious time for sleep and leave you restless.

Despite you not having the reins on your investments in index funds, it does not mean that you’re safe. Index funds don’t remove the worry and stress you feel regarding the market’s performance. You might actually end up stressing even more since you can’t do anything about it.

You don’t give the call about removing investment in the asset that’s not performing well. You don’t get to choose when to put investment on a company that you think might do well. This can potentially induce more worry and stress, dampening your personal satisfaction.

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Types and Examples of Index Funds

Here are the different types of index funds that you can choose from and their examples.

S&P 500 Funds

This tracks the S&P 500 index which has around 500 U.S. large company stocks.

  • Schwab S&P 500 Index
  • Fidelity Spartan 500 Index

Large Growth Stock Index

These normally track indices like the Russell 1000 Growth index, the Nasdaq Composite, or the Nasdaq-100. These focus on company growth stocks by market capitalization.

  • Vanguard Growth Index
  • Fidelity NASDAQ Composite Index

Large Value Stock Index Funds

These funds track indices such as Russell 1000 Value index or the S&P 500 Value index. Generally, value stocks are those underappreciated in the market and sells at a discount.

  • Vanguard High Dividend Yield Index
  • Vanguard Value Index

Mid-Cap Stock Index Funds

These track indices like the S&P MidCap 400 index or the Russell Mid Cap Index. These are indices that include a mix of both growth and value.

  • Northern Mid Cap Index
  • Vanguard Mid Cap Index

Small Cap Stock Index Funds

These funds track indices such as the Russell 2000 Index or the S&P SmallCap 600 index. Much like the previous one, these include indices that have both growth and value styles.

  • Northern Small Cap Index
  • Schwab Small Cap Index

International Stock Index Funds

These normally track indices like the MSCI EAFE index or the MSCI ACWI index. Both consist of stocks of companies outside the United States.

  • Vanguard Total International Stock Index
  • Schwab International Index Fund

Bond Index Funds

These index funds track the Barclays Capital Aggregate US Bond Index, which consists of over 3,000 bonds.

  • Vanguard Total Bond Index
  • Northern Bond Index


If you’re the type of investor that would like to invest in a less-stressful environment, then you can try investing in index funds. There are advantages and disadvantages that can help you in deciding whether this will be the right investment for you. We also provided you with a guide on various index funds that you can choose from.

Never neglect due diligence and learn more about your investment before making any final decisions. Don’t second guess your instinct, but also remember to base decision on facts.

Index funds offer you stability in the volatile financial industry. But there are also other factors that you have to consider to make a solid decision.

If you want to learn new things and learn strategies about the market, BWorldpedia is the site you should visit! We provide profound and useful insights about the market and across a plethora of topics related to it. Also, register an account now with BWorld and start your investment journey.

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