Investing in enhanced index funds has been touted as a superior form of investment over the traditional mutual or index fund. The enhanced index fund has some advantages to it as an investor. However, there are some things that you want to know about how this type of fund works before getting involved.

The Index Fund

In order to understand how the enhanced index fund works, you first need to know the basics of an index fund. A financial index is a measure of a certain group of stocks and the stock market. A common example of a financial index is the S&P 500. The S&P 500 is made up of stocks from 500 of the best companies in the market place today. The stocks in this index are designed to mimic the market as a whole as the majority of business is done through these 500 companies.

An index fund is a mutual fund that aims to replicate the results of an index. Therefore, they invest in stocks that make up this index in an attempt to re-create the results that the index provides. This can be a good long-term strategy because your portfolio will go up and down with the market. Over the course of history, the value of the market has always gone up. As a long-term investment strategy, this provides you with steady growth.

The Enhanced Index Fund

For many years, the index fund was considered one of the best investment vehicles around. However, in recent years, certain investment companies have come out with the enhanced index fund. This is an investment vehicle that tries to beat a financial index instead of just staying with it. Therefore, this is not as simple as buying the stocks that make up the index. More advanced techniques are utilized to achieve these results.

Active Management

The fund managers for this type of index fund, have to analyze the stocks that they choose, and weigh the funds for particular companies. The fund managers achieve this by creating a number of different financial metrics from which to choose the stocks. Sometimes, they will even use advanced computer models to decide which stocks to buy the most of. They will break down industries and sectors to see where the majority of the funds need to go. Through this method, they hope to be able to beat the index as a whole by focusing on the best parts of the index and staying away from the parts that under-perform.

Risks

While the traditional index funds is considered a low risk investment, this type of index fund has a little more risk involved. Since it is actively managed, this means that someone is choosing which investments to put in the portfolio. There is always the chance that they do not choose the right stocks to buy. When this happens, the returns of the fund could be lower than what the financial index provides.

$7 Online Trading. Fast executions. Only at Scottrade