An index fund is a fund designed to mimic the composition and performance of a financial market index. Index funds charge lower fees than actively managed funds, and they generally follow a passive investment strategy as opposed to actively picking out stocks to consistently beat the market.
How can I use index funds when I invest in stocks?
- You can use it as a passive investment tool. Index funds do not attempt to beat the market, so while you will not incur losses more than the market during a downturn, you also do not stand a chance to outperform during a bull market.
- Index funds provide a natural source of diversification, similar to investing in the market index itself. This is especially important during high market volatility caused by uncertain events like the current global pandemic, as investing in a basket of assets that are weakly correlated can act as a hedge against potential losses.
- However, index funds only track equities, and some index funds may only track equities that are heavily weighted towards a particular sector, such as funds that track the Nasdaq Composite Index. The Nasdaq Composite Index is focused on information technology equities, so funds that tracked it would have suffered large drawdowns from the tech selloff that occurred in early September 2020.
- Index funds can be a good source of ideas. For example, suppose you are interested in investing in ESG-related equities (companies with good scores in their environmental impact, social responsibility, or good governance). In that case, you can look at the composition of various ESG funds to hand-pick companies that might interest you.
Debt to Equity Ratio
Used to evaluate a company's financial leverage and is calculated by dividing a company's total liabilities by its shareholder equity.
Profit is the financial benefit realized when revenue from a business is higher than the costs and taxes involved in operating that business.
Alternative investment class composed of funds that invest directly in private companies or that buy public companies and take them private
Time of declining economic activity, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and sales.
A stimulus package is a coordinated effort by the government to increase spending and investment to "stimulate" an economy out of a downturn.
Shorting a stock
Trading strategy that tries to take advantage of the decline in a stock price by borrowing a stock and sell it now while planning to repurchase it later for a lower price.
Market-capitalization-weighted index tracking the performance of the 500 largest U.S. companies