Understanding Index Funds
Index funds can be part of a sound investment strategy, helping you safeguard and grow your wealth. While by themselves they will not make you rich, they can help you achieve your financial goals.
Index funds are designed to mimic the behavior of a particular market by compiling a broad array of different stocks and bonds. In practice, fund managers will pool monies from multiple investors to purchase a number of different holdings. This diversifies your portfolio and shields you from major losses if one particular company or investment goes bankrupt.
Because index funds generally reflect the performance of the market, when it goes up so will your wealth. The opposite is also true, however, and when the market sinks your investment will lose value.
The Value of Index Funds
Index funds generally mirror the behavior of the market, which historically has been a healthy investment. The Standard & Poor’s 500 (commonly referred to as the S&P 500) is made up of some of the largest companies listed on stock markets in the United States. Though it can fluctuate year-to-year depending on the state of the economy, over the past 60 years it has consistently delivered close to 10% returns.
Index funds are a relatively easy way to diversify your portfolio as well, allowing you to shield yourself from the ups-and-downs that individual companies might experience. For those keen on investing in particular sectors, there are index funds that will allow you to focus your monies on areas that you believe possess unique value such as technology stocks, real estate, or even more specialized areas such as robotics and artificial intelligence.
These funds also tend to be more passively managed, as value is gained over time and not via the constant changes in the market that day traders try to capitalize on. This lowers the fees that you will need to pay fund managers.
The Limits of Index Funds
Like all investments, your rewards are directly proportional to the risks you are willing to take. Index funds will do as well as the market, so your gains will be limited by its overall performance.
While you will not accumulate the massive wealth enjoyed by the individual investor who decided to purchase Apple (NASDAQ:APPL) or Google (NASDAQ: GOOGL) at the optimal moment, you also will not lose your nest egg if you made a bad bet on a company that goes belly-up.
This translates into a lack of control over your portfolio, which can be difficult to stomach, if this is an important consideration for you. By definition your decision-making is limited, and index funds erase your ability to follow that hot stock tip you heard about from your neighbor.
Index funds are also meant to be thought of as longer-term investments. If you need something steady and predictable in the short-term, this probably is not the right thing for you.
Conclusion: Understanding If Index Funds are Right for You
Like most investments, the longer you are able to keep your monies in the market, the better off you will be. This is not only because the stock market’s general upward trend can best be enjoyed in multiyear tranches, but also because of the magic of compound interest.
Compound interest can be understood as the ability of your interest to earn interest, allowing your wealth to begin ramping-up at increasingly rapid rates as time goes by. You can use TipRanks’ compound interest calculator to understand how this concept works in practice, and how different starting sums, rates of return, and compounding intervals will impact your overall accumulation of wealth.
So, can index firms make you wealthy? Not by themselves. They are a great tool to increase your wealth over the long-term, but it depends on you. The more you can invest and the longer you can keep your money invested (and re-invested), the better off you will be.
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