What is an Index Fund?

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index fund

Index fund is a type of mutual fund that tracks and replicates how a specific market index performs. It is designed to mimic or adhere to the elements of a stock market index.

A market index is a measure of the performance of individual stocks, bonds, mutual funds, and other investment vehicles. Market indices are used by investors to gauge the overall performance of a market.

Index funds usually have low operating costs and a diverse portfolio of stocks, making them a popular choice for long-term, passive investing. 

How Index Funds Work

Passive investing is the approach used by index funds. This means that the fund manager will not actively buy or sell stocks in an attempt to beat the market. Instead, the fund will hold the same stocks as the index it tracks.

Index funds don’t try to beat the market through active management. They buy stocks from every company listed on an index to mirror its performance. 

This means that the performance of an index fund should be very similar to the performance of the index it tracks.

For example, if the S&P 500 index has 500 companies and an index fund has $100 million in assets, it would buy $200,000 worth of shares in each of the 500 companies. When the index changes, such as when a company is added or removed from the S&P 500, the fund will adjust its portfolio accordingly.

Index funds are popular among investors who want to invest in a diversified group of stocks with low management fees and minimal research.

Index Fund Examples in Nigeria 

  • The Standard IBTC ETF 30
  • Vetiva Griffen 30
  • NGX Oil and Gas
  • NGX Afrinvest Div Yield Index
  • NGX Premium
  • NGX Pension
  • NGX Industrial

Index Funds in other parts of the world

  • S&P500
  • MSCI World Index
  • FTSE 100
  • Russell 2000
  • Nikkei 225 

Advantages and Disadvantages of Index Funds

1Low management feesLess flexibility
2Predictable performanceRisk of underperformance
3Low turnoverNo outperformance
4DiversificationLimited control

Advantages of Index Funds

  • Low management fees: Index funds typically have lower management fees than actively managed funds.
  • Predictable performance: Index funds track a market index so their performance is more predictable, making them a good choice for long-term, buy-and-hold investors.
  • Low turnover: Index funds are passively managed, hence lower transaction costs and taxes.
  • Diversification: They provide diversification across several stocks or bonds, reducing the risk of an overly concentrated portfolio.

Disadvantages of Index Funds

  • Less flexibility: An index fund manager is constrained by the index they’re tracking. They have to less flexibility to adjust their portfolio in response to market conditions.
  • Risk of underperformance: An index fund can underperform other investments during market downturns.
  • No outperformance: Index funds will only perform as well as the index it tracks. They cannot outperform the market.
  • Limited control: Investors have limited control over the assets included in an index fund, which means they can’t avoid investing in companies they don’t believe in.

How Can I Invest In Index Funds?

Here are general steps to invest in an index fund:

  1. Research different index funds: Compare fees, performance, and other details of the funds to find the best fit for your investment goals.
  2. Open a brokerage account: You’ll need a brokerage account to invest in an index fund. You can open an account with a traditional or online brokerage firm. 
  3. Fund your account: This is pretty self-explanatory. You can do it via the payment options provided by your broker. 
  4. Buy shares: Once you have money in your brokerage account, you can buy shares in the index funds you choose—from the brokerage’s website or mobile app. 
  5. Monitor your investment: Keep an eye on the performance of your index fund and the market fluctuations that may affect it.
  6. Consider automatic investments: This means a certain amount will be automatically transferred from your bank account to your brokerage account regularly, and then invested in the index fund. 

Read more about Systematic Investment Plan (SIP).

Note that these steps may vary depending on the broker or the fund you choose.

However, you can avoid this stress and buy an index fund directly from a mutual fund provider. 


How to invest in a mutual fund on Cowrywise

  • Download the Cowrywise app here
  • Create your account or sign in to your existing account.
  • Tap “Invest”
  • Then choose your preferred mutual funds option.

Can you lose with index funds?

An index fund rarely loses its value, although uncertainties exist in the financial world. One explanation for this is that most index funds are very diversified.

Are index funds suitable for beginners?

Index funds are a good option for new investors who want to explore stocks without taking on high risks. Beginners could use them as the foundation for their introduction to the stock market.

Bottom Line 

Index funds are hands-off, and you could build a diversified portfolio with solid returns. By tracking a market index, these funds aim to provide returns that are similar to the overall market. Index funds are a great option for long-term, passive investors. With the right research and a solid investment strategy, index funds can be a valuable addition to any portfolio.

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