Imagine you are a newbie investor who has just entered the stock market. You want to build a profitable portfolio but lack the required skills and knowledge. You find different types of mutual funds to choose from, each with its level of risk and potential return, making it difficult to decide how to begin. That is where index funds can be useful.
Index funds offer a simple, reliable way to start investing without the hassle of researching individual investments or worrying about timing the market. Since these funds follow a passive investing approach, investors buy into the fund, mimicking the index holdings. The fund then adjusts its holdings to match the index’s performance, making it a “set and forget” investment option.
Starting their investment journey with index funds can be smart for anyone new to the market. Here are four reasons why.
1. Eliminates human discretion/bias
Most investors are vulnerable to emotional decisions or sticking to the hot trends in investment. But index funds can take the guesswork out of investing and help to eliminate human bias.
These funds operate via indexes or benchmarks that track different assets. As the performance of any particular investment or stock changes, index funds keep on re-balancing to maintain their portfolio, closely following the underlying benchmark. So, any potential human error or bias that may occur due to the fund manager’s approach or perception is eliminated.
2. Offers a low-cost investment option
When you invest in mutual funds, you usually pay an expense ratio, a fee that covers management, administrative, and other expenses of running the fund. Actively managed funds have a higher expense ratio as they rely on the expertise and knowledge of fund managers and analysts.
Index funds have lower fees by minimizing the costs involved in fund management. Since index funds only need to track the benchmark index, there is no need for a fund manager to carry out detailed research or analysis. This makes index funds the right choice for new investors who want to begin investing without paying high fees.
3. Diversification in a single investment
When you invest in index funds, you get diversification in a single investment, holding several stocks across various sectors and industries. So, instead of worrying about buying individual stocks separately, you can focus on your overall investment strategy.
4. Besides equity, index funds are available for other asset classes, also
Many people relate index funds with the stock market but are also available for other asset classes, such as debt instruments. Debt index funds help investors who want to earn a steady income stream but don’t want to take on as much risk as investing directly in individual bonds.
Moreover, you can invest in different index funds, including broad-market index funds, market capitalization index funds, sector-based index funds, and international index funds. These categories allow investors to diversify their portfolios, minimize risks, and capture potential returns from different strategies.
To sum up
Index funds are an ideal starting point for newbies because of their low complexity, diversified exposure, and low fees. Investing in index funds via a SIP (systematic investment plan) can help new investors build their portfolios with small, regular contributions. This helps to develop a disciplined approach to investing and benefit from long-term market growth.
Also, note that different index funds carry other risks and investment strategies, so it’s wise to take guidance from a financial advisor to optimize your portfolio for long-term success.