What is an Index Fund, and How Can it Work for You?

You know what they say: slow and steady wins the race, and the same can be said with investing in index funds. Index funds have been popular for people wanting a more hands-off, cost-effective approach to investing. How exactly does that work? Let’s dive in.

What are index funds, anyways?

An index fund is a mutual fund or exchange traded fund which is built to match and/or track an index. The S&P 500, The Dow Jones Industrials, and the Barclays Aggregate Bond Index are all examples of indices. They’re passive funds, meaning they buy and hold the components of the index, rather than trying to own the ‘best’ stocks that they believe will outperform. Index funds aren’t meant to “beat” the market or get anyone rich quick. Instead, tend to be lower-cost funds, meant to be held for the long term.

Why do people choose index funds?

One of the reasons people choose index funds is that they charge lower fees, as they’re not actively managed. That means more of the investors’ money goes towards the actual investment and less goes to fees.

Index funds are generally diversified, meaning they own many different stocks or bonds. That’s good for investors, as putting all your eggs (investment cash) into one basket (one stock/bond) can backfire if the basket breaks (company fails).

Lastly, index funds can be good options for people who don’t have the time, interest, or resources to research each individual stock they want to invest in. Instead, they can simply invest their money and watch it grow with the market.

The Efficient Market Hypothesis and index funds

Enthusiastic fans of index funds often look at the Efficient Market Hypothesis (EMH) as the reason they’re so great. The Efficient Market Hypothesis states that all the necessary information about stocks is already factored into their price. The hypothesis says, then, that it’s pretty much impossible to “beat the market” by finding deals or “undervalued” stocks. Therefore, the investor is better served to own the entire market in a low-cost index, rather than to pay extra for a manager to try and ‘beat the market’.

Wrapping up index funds

We get it—not everyone wants to spend their free time researching and trading stocks. For those wanting a more relaxed, hands-off approach to investing, index funds can be a solid option.