3 Reasons Why You Should Invest In Index Funds

Hi everyone, thank you for coming back to my blog. I hope you found my last blog interesting and useful, where I covered ‘Investing For Beginners (Part 3)’.

In today’s blog, I am going to show you reasons as to why you should consider investing in index funds and make these a part of your investment portfolio.

An index fund will often buy shares in every company listed on the index it is tracking, for example, a FTSE 100 index fund might buy shares in every company in the FTSE 100 — all 100 of them.

In practice, buying every single share or bond in an index isn’t always possible or cost-effective because some of the main global markets contain hundreds or even thousands of shares or bonds.

So sometimes the index fund might buy a representative sample of shares or bonds instead.

These are the reasons why you should consider investing in index funds:

1. Index funds are a simple way to diversify

An index fund has a mix of many stocks and bonds, which will help you diversify your portfolio and therefore help to minimise your portfolio’s related risk. Because money is spread out across a variety of assets rather than just a handful of individual stocks, your portfolio is less likely to see sharp, short term fluctuations.

Diversification also offers another important benefit: It increases the potential for your overall return. By freeing yourself from the arduous task of trying to accurately pick the winners, buying an index fund means you will have a mix of some of the winners…and some of the losers too.

While broad market index funds offer the most diversification benefits, there are index funds that have a narrower focus. For example, you can buy index funds that track companies of various sizes (large-, mid- or small-caps), within specific industries like technology, healthcare, or energy, and those that are listed on international stock exchanges.

2. Index Funds have lower fees

Index funds pool money from a group of investors and then buy the individual stocks or other securities that make up a particular index. That model helps to reduce the associated costs that fund managers charge, compared to those funds where someone is actively strategizing which investments to include.

Fees matter because they can cut into your overall return. By not paying a lot for someone to pick and choose your investments, you get to keep more money to reinvest in your portfolio.

3. You don’t have to be an expert in index funds

While professional investors make a living by trying to outperform the market (by picking winning stocks) that strategy is difficult to successfully execute over a long period of time. With index funds, you don’t have to pick the winning stocks to benefit from the market’s overall gains.

There are some inherent risks that come with investing in the stock market, but investing also offers a higher rate of return than the interest rates you will learn on a savings account. The S&P 500, an index representing the 500 largest U.S. companies, has delivered average annual returns of almost 7% (after inflation) going back a very long time.

And if that was not enough to convince you, even billionaire investor Warren Buffett (whose stock picks are closely followed) has repeatedly recommended index funds, saying, “In my view, for most people, the best thing to do is to own the S&P 500 index fund.”

Now, you don’t have to invest in the S&P 500 index fund as there are so many more index funds out there, but the choice is yours and you should only invest once you have done your research first!

Until next time, thank you and stay safe.

Finance professional, blogger and a firm believer in making money work for you, instead of you working for it.