What It Is

The best way to explain an index fund is by example. If you open a book, often the first couple of pages will contain an index, which summarizes the content. Similarly, an index fund is a fund that summarizes the stock market or a big part of it. A proper index fund will have a large variety of stocks that track a particular market index.

Pros

An index fund’s main advantage is that it is inherently diversified, which helps decrease risk. When an index fund gains or loses value, it is usually not because of one stock, but because the overall market went up or down. Usually, an index fund will reflect the economy as a whole. Another advantage is that the fees for index funds usually are significantly lower than for other fund types.

Cons

An index fund’s primary advantage also could be considered its main disadvantage, since the fund inherently can’t outperform the stock market. Also, when stocks are bought or sold by the fund, to reflect changes in the index it is based on, the investor will face additional costs.

Alternatives

References

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