Warren Buffett, one can say the Shakespeare of the investment world, with a net worth of more than US$82 billion and who has been outperforming the market for decades now, has advised that low-cost index funds are the smartest investment choice that people can make.
For a first-time investor, investing in index funds is often considered a safe option to begin with.
What is an index fund?
You must have come across the term mutual fund (MF) or exchange-traded fund (ETF), that holds all or is a representative sample of stocks offer specific index (say S&P Midcap 500).
The goal is to match the performance of the benchmark index with that of the representative stocks with which the fund is created, as much as possible.
Who can invest in index funds?
Though it does not require you to be an expert in the financial market, investment in an index fund is usually preferred by individual investors who have time, skill, or patience constraints to manage a portfolio of stocks.
Often termed as a passive mode of investment, index funds are relatively low cost and offer better diversification options as compared to stocks. And given the patience level, a passive investor can outperform an active investor over the long term.
How does an index fund work?
In an index fund, each stock is allotted a certain weight. For example, if you invest in a specific investment fund where company A is allotted 10% weight and Company B holds 5% weight, the index fund will also mirror the same investment pattern to these companies.
The performance of the index will have a direct impact on the performance of the index fund.
What are the Index funds available in Canada?
For a Canadian investor you have some great index funds that are available for investment(source:kalkinemedia):
- Vanguard S&P 500 ETF (VOO) - Tracks S&P 500 index.
- SPDR S&P 500 ETF (SPY)
- Fidelity® Zero Large Cap Index Fund
- iShares Core S&P 500 ETF (NYSE:IVV)
- Schwab® S&P 500 Index Fund
Bottom line
Index funds come with a lot of pros such as:
- Low fees.
- Lower exposure to tax.
- Passive management tends to outperform the benchmark index.
- Offers broad diversification.
Though it has minor flaws, such as no downside protection and lack of taking advantage of opportunities, the pros outweigh the cons keeping in mind that in the long run, it is the investor who is going to reap the benefits.