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What is an Index Fund?


The main purpose of an index fund is to allow investors to access rates of return commonly found in the stock market without being exposed to much of the risk involved when investing in the stock market. Index funds typically consist of many different individual stocks and the index funds price (value) is directly correlated to the underlying stocks the fund chooses to hold in its portfolio.

How do index funds differ from Stocks?

Index funds differ from individual stocks in a variety of ways. One very important difference between stocks and index funds is their correlation to the overall market and/or industry. For example, it is possible for a sing car company to go belly up within a week, while all the rest of the automotive industry grows 1-2% in a week.

If there was an index fund specifically for the auto industry(for example CARZ) it would've reflected the fact that the automotive industry did very well for the past week without suffering much, if any, loss from the one company that did terribly. A few very common index funds investors use to get a rough estimate of investor sentiment in the overall market is the S&P 500 and the Russell 2000. These index funds have very high volume and a large correlation to other market making factors such as foreign policy and unemployment.

Are index funds safe?

What is an index fund?

Another significant advantage to index funds is that they are much safer than investing your entire portfolio into a single stock or security. This was shown in the previous example above, when a hypothetical stock flops, then the investor who was all in on that stock would lose everything. However with an index fund, you would need every stock in the entire index fund portfolio to tank. Which in the case of the S&P 500 would be 500 different stocks, which is highly improbable.

How many different types of index funds are there?

There are numerous different kinds and types of index funds. Among the most popular are Large cap index funds and Growth index funds. As the name implies the large cap index funds hold a portfolio mainly comprised of large market cap companies such as GE, Walmart, Apple, Microsoft, Google and so on.

Growth index funds typically hold stocks that focus on growth, many of these stocks wont pay any dividends because they would prefer to reinvest in the company and use the funds to grow their business and therefore the value of the shares would go up.

There are many other index funds out there such as high yield index funds and even international index funds. The high yield ones focus on making dividend payments to shareholders, check out Global X ETFs for more information. As for the international index funds, they do exactly what the name suggests and focus on stocks from abroad. Some examples of international index funds include, FSPSX, SWISX, PXINX and VTMGX.