Index Investing

What is it? Also referred to as indexing, it is a method of passive investing whereby a fund buys the same stocks in the same proportions as in a target index.

What is ‘passive investing’?

It means investing in a fund whose objective is to match the ‘total rate of return’ on an underlying market or part of the market.

What is an ‘index’?

An index is a quantitative measure of the total returns that have been earned by some underlying group of securities (whether stocks or bonds) over a fixed period of time. The return includes all dividends and interests received, plus the change in the price of the security during the time.

The purpose of index investing is to buy and hold the index. However there are those who believe that technical analysis and fundamental analysis are wrong. This is because ideally the past performances of securities need to be evaluated to accurately predict the future returns. However there are others who say that past market returns are actually no indication of the likely future returns.

The return achieved from indexing is the return of the index. If the index tracks a market sector, then the return is that of the sector. If the index tracks the market as a whole, then the return is that of the market. Practitioners of indexing make a conscious decision not to try to outperform the market, rather they decide to obtain the market return.

Advantages of Index Investing

These are a few of the reasons why many prefer index investing to others.

They cost less: Traditional mutual fund investments tend to be higher cost investments due to the turnover of equity components, which generate transaction fees with brokers. And these transaction fees can go up quite a lot actually. For an investor, these fees naturally reduce the overall return on the mutual fund portfolio.

Lower risks: Smaller cash position.

The tax burden is less: The fund turnover in this method is much lower. Because of this, the capital gains taxes are much less for the investor.

Gives better traditional returns: After taking in to consideration the management fees, index funds give better returns than the average managed mutual fund.