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What are Index Funds?

Before I get into index funds, let's discuss what an index is. In this context, the word “index” refers to a stock index. A stock index measures the growth/performance of the stock market. The most popular indexes in the US include the S&P 500, the Dow Jones Industrial Average, and the Russell 2000. Each index is made up of many different individual stocks, so its performance isn't based on one factor. For example, the S&P 500 is composed of the stocks of 500 major companies, ranging from Apple to Tesla to Southwest Airlines. Because it’s composed of so many different companies, it is a good indicator for the overall stock market because in order for it to increase in price, the majority of companies in it must also be doing well.

Index funds are simply assets which track the overall index. Through index funds, regular people can invest in the overall stock market without actually owning every single company in an index. So, by investing in an S&P 500 index fund, you can enjoy the benefits of owning all 500 companies in the index, without actually owning them. This is just one of their advantages.

Index funds are good for two key reasons. First, they’re great for anyone who doesn’t want to own individual stocks. By purchasing an index fund, you don't have to conduct any of the research that comes with purchasing an individual stock, as index funds don't have earnings and other similar analysis metrics because they’re not a company. So, if you have no interest in investing in individual companies and you just want to buy an asset that is generally safe without too much research, index funds are great for you.

The second reason is because they have a history of growing over time and being relatively low-risk. Because index funds track hundreds of companies, they have a history of returning sizable long term profit with little risk. For example, the S&P 500 index has returned nearly 10% per year since its inception. If you had invested $1000 into the S&P 500 in 1990, you would now have over $10,000. This history of profit is because each index is composed of dozens of companies, so in times of economic expansion (the US has experienced strong overall economic growth for a good amount of its history) when those companies are doing great, selling products and creating new technologies, the index grows too. For the most part, when the economy does well, so do stock indexes*. Additionally, indexes are usually associated with lower risk because they are made up of so many companies, so even if one or two of those companies fails, they only make up a small portion, so the index wouldn't be affected too severely.

If you want to purchase an investment that has a history of solid profits and low risk, index funds are great. They provide long term stability and growth, making them ideal for retirement.

Index funds are usually bought in the form of an exchange-traded fund, or an ETF. This means the funds it bought and sold on the stock exchange, so you can purchase them normally through your brokerage. This is different from other funds, like hedge funds, which actually require you to contact them to invest. Investing in index funds is easy if you have a brokerage account, and if you don't, don’t worry, I’ll upload an article showing how to open one in a future article.

In my opinion**, index funds are great assets for anyone starting off with their investing journey. They have provided safe, stable returns for decades. They are easy to buy and don’t require much research. If you're just beginning to invest, and are unsure of what to purchase, start with index funds as the basis of your portfolio, and go from there.

*However, it is important to note that the stock market does not correlate with the economy. During the recession caused by Covid-19, when unemployment numbers have been over 10% for months, many US stock indexes have been extremely profitable, hitting their highest prices ever.

** I am not a certified financial advisor. Everything I say is purely my personal opinion. Please conduct your own research before making any investments.


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