A Beginner Guide: What Are Index Fund Investments?

Index funds offer investors an easy foray into the stock market with lower risks and lower fees than actively managed mutual funds and other investments. Passive investing via an index fund enables you to invest in the stock market in a low-cost, low-risk way. You’ll also benefit from well-diversified investments and attractive returns – but what exactly is an index fund and how does it work?

Well, index funds are made up of individual stocks that mimic the corporations, companies, and all-round performance of one particular market index. The investor will choose and invest in an index they wish to track, such as the P 500 index fund or the Wilshire 5000 total market index, for example. From here, they’ll purchase shares of that particular index fund and reel in the returns of their investment.

But is it really that simple? In this guide, Instant Loan reveals everything the average investor needs to know about how an index fund works, who should invest, and what the best index funds are in Singapore right now.

What are Index Funds?

Simply put, index funds or index mutual funds are grouped funds made up of individual stocks that follow or “track” an individual market index or benchmark index, like the P 500 index or Wilshire 5000 total market index, for example. Unlike actively managed mutual funds, exchange-traded funds (ETFs), or other investments that usually try to “beat” the market, an index fund tries to “be” the market or mirror its activity, enabling passive investing opportunities.

In short, an “index” itself is basically just an independent measure of a stock price or fund’s performance. This could be individual stocks or other asset classes and benchmark index examples such as the Dow Jones industrial average, which can either perform well or poorly on any given day.

By purchasing an index fund, investors can effectively indirectly buy an entire market – i.e. the securities that make up that complete index. In a sense, index fund investors are building a hands-off portfolio characterized by more balanced risks and less volatile fluctuations than individual stocks investments, due to the grouping of different individual stocks and asset classes involved. 

How Does an Index Fund Work?

Index funds offer investors an opportunity to earn money from passively managed funds. These are quite different from more traditional actively managed funds, whereby an asset manager will actively buy and sell individual stocks or investments.

While the active management route usually requires paying expensive management fees and devising a winning active management strategy that will earn returns, passive investing is much more hands-off – and also makes for a low cost alternative.

How an index fund works is simpler than it sounds – a fund manager will build an investment portfolio that reflects a pre-existing stock market index, such as the P 500 index. From here, the performance of that investment portfolio or “index fund” will closely follow that of the benchmark index used to create it.

What Are the Pros and Cons of Index Funds?

Now we’ve clarified what an index fund is and how they work, let’s take a closer look at the top advantages and disadvantages of index funds when compared to other types of investments:

Pros

1. Low Cost and Expense Ratio

Index funds typically have a much lower management expense ratio than actively managed investments.

The fund’s expense ratio, which is made up of various operational expenses like taxes, brokerage account fees etc., is lower purely because your fund managers will be replicating the performance of a pre-existing benchmark index – which doesn’t require so much work, meaning a low cost overall.

2. Strong Returns in the Long Term

It’s not uncommon for index funds and other passively managed funds to outperform actively managed mutual funds – as the latter won’t always hit their benchmark index targets and expectations. What’s more, passively managed funds follow the theory that the market always wins, and therefore don’t overstretch themselves trying to beat it.

3. A Good, Low-Cost Option for Buy-and-Hold Investors 

As long-term returns are generally stronger with index mutual funds than classic mutual fund variants, they are also an excellent fit for buy-and-hold investors.

Fees and trading costs are also typically much lower than those associated with competing financial products – you’ll usually pay 0.20% or less in fees, compared with around 1.00% on actively managed mutual funds or exchange-traded funds.

Cons

1. Limited Flexibility

If you want to invest in an index fund, you’ll need to be happy with the hands-off nature of this investment type. Whether you’re making a minimum investment to grab a slice of the P 500 index fund, or you wish to put aside a large sum of money, you’ll need to sit around and wait for that investment to mature and won’t have much say on what goes. Many mutual funds of other kinds will be a better fit if you want an actively managed fund.

2. Market Volatility and Safety

While most index funds track fairly safe underlying index types, any asset classes can potentially be bundled into these funds. Following certain markets, such as the oil industry, for example, could expose your fund to market volatility and there’s always a chance you could lose money when you buy index funds. That said, index funds are still usually less volatile than individual stocks.

3. Gains Can Prove Limited in the Short Term

Index funds may prove profitable in the longer term, but short term investors are likely to find them inflexible. The best profits are usually delivered over long periods of time, so if you want to buy index funds only to sell them on six months later, there’s a chance you could lose money.

Should I Invest in an Index Fund?

If you want a low cost investment opportunity that’s 100% passive, achieves high returns in the long-term and enables you to diversify your investment portfolio across different mutual fund company types, individual stocks and more, index funds are likely to prove to be a very safe and satisfying investment option.

Conversely, if you want to make short-term capital gains and have more flexibility and control over your investments, actively managed funds will probably be a much better fit for you. Let’s take a look at the different index fund and mutual fund types that are on the market right now.

What Index Funds, Exchange Traded Funds or Mutual Funds Should I Invest In?

Clearly, there are a lot of different things you’re going to want to take into consideration before you make an investment in an index fund, particularly when it comes to passive versus active investing and short versus long term returns. 

But what else do you need to keep in mind? Well, you should always try to make sure:

1. Your Index Fund is Affordable

You should think carefully about what kind of investment minimum is right for you, what kind of benchmark index you’d like to track and whether purchasing a small slice of the fund is better for you than buying a full, main course mutual fund.

2. Your Index Fund is Performing as Should Be Expected

Every good index fund should accurately mirror the performance of the market index it is following. Be sure to check returns against the benchmark index itself for consistency and steer clear of any funds that are lagging behind the original index by more than the offered expense ratio.

3. Index Funds are Definitely a Better Option for You Than Stocks

The stock market isn’t for everyone, and index funds are definitely an excellent fit for passive investors, but what if you’d prefer something a little more hands-on? Always consider the alternative investment options available to you and settle on whatever is best for your unique situation.

Interested in understanding more? Find out in the best index fund in Singapore.

7 Best Index Funds for Singaporeans to Invest In

With so many popular index fund options available to Singaporeans these days, it can sometimes be difficult to choose which will best meet your investment goals and ambitions. Let’s compare some of the most popular funds on offer right now:

Where Can I Invest in Index Funds? 

There are several ways you can get started with investing in an index fund. A few popular options, include:

• Local fund managers in Singapore

• Full service brokers like Tiger Brokers and Plus 500

• Online stock trading platforms like Interactive Brokers and Saxo Markets

• The Singapore Stock Exchange (SGX)

That said, it’s important to carefully consider your own unique investment goals and preferences before you start exploring the market. Better yet, seek advice from a financial expert or professional before you start shopping around. You might also want to consider commission-free trading platforms such as eToro, too.

Check out the ABF Singapore Bond Index Fund review.

Frequently Asked Questions (FAQs) About Index Funds

Are Index Funds Safe?

Investing in an index fund is typically considered much safer than direct stock market investment for many reasons. You can expect less volatility and a greater diversification of your assets.

Why Do Index Fund Investors Lose Money?

If your fund is performing well, you should be able to achieve profitable returns by holding onto it in the long term. However, each time the base index used by your index fund drops, the same will happen to your returns, so be cautious of this.

What is an ETF?

An ETF or “exchange traded fund” is a grouping of securities listed on a stock market, such as the SGX or NYSE. In most cases, ETFs are passive investments similar to index funds, but you should always double-check before investing, as ETFs can come in many different forms.

What Are the Key Differences Between Index Funds and ETFs?

While Index Funds will track a popular market index, ETFs are usually physically listed on the stock exchange themselves. They are also usually priced differently – and can be bought and sold in a more flexible manner.

Are Long Term Investments Always More Profitable?

Not necessarily, no. While holding onto an index fund for 5-10 years will usually be more beneficial than buying and selling quickly, other more active forms of investment, such as mutuals and stocks, can often prove more profitable in the short term instead.

How Do I Make Money with Actively Managed Assets?

Active investment requires a much more hands-on approach, which may involve appointing an asset manager and keeping a close eye on the market at all times for fluctuations and volatility.

Which Index Fund is Best for Me?

There are tons of different types of funds available to investors on the market right now, and which one is best suited to you will depend entirely on your goals, risk appetite and personal preferences when it comes to making stock market investments.

Conclusion – Is Index Fund Investing Right for Me?

Between expense ratios, active versus passive investing and the dizzying array of investment options out there in today’s market, there’s an awful lot to get your head around when it comes to getting started with index fund investments. Before you dive right in and invest money in the first fund that tickles your fancy, here are a few important things to keep in mind:

Key Takeaways

• An index fund is a form of passive investing that follows a benchmark index and should perform in a similar way to that particular index.
• Index funds function best as a longer-term investment and might not be suitable for day traders or investors looking to make fast cash.
• Other types of more active investment, such as actively managed mutual funds, ETFs and individual stocks investments on the stock market, might be a better fit for some investors – so be sure to compare all your options.

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