"Buying the haystack" is a simple way to say you should invest in everything instead of trying to pick winners. The term was made famous by the legendary Jack Bogle who pioneered the idea of index funds.
Now imagine you live in a village with 10 business. Each business either sells groceries or hardware or provides a service like a laundry or a hair cutting saloon. If you had the option to invest some money into the businesses which one would you chose? Here comes the complex part. How accurately would you know which of the businesses would do well over the next 10 - 20 years? What if another laundry opened next door leading to the original one shutting shop. What if the family running the hardware store starts to lose interest in the business and starts to lose money? Selecting the right business from among the various existing business is a tough one. It is a very complex one. And most often even the brightest tend to go wrong.
What if you could buy all 10 businesses in the village? That takes away the risk of any one of the businesses we invested in going under. Needless to stay, the population of the village and the demand for goods and services will continue to grow. In other words, the total value of the business in the village will continue to grow. Hence investing in all the businesses in the village gives you the opportunity to get a pie of the share without the risk of selecting one or more specific businesses.
 |
| CLICK HERE |
That brings us to Index funds. An INDEX FUND is a type of a mutual funds that invests across the entire market or an entire segment of the market. It takes away the investing biases of an individual. Investing in index funds has long been considered one of the smartest investment moves you can make. Index funds are affordable, enable diversification, and tend to generate attractive returns over a longer period of time.
As mentioned above, the biggest benefit of an index fund is the elimination of personal bias. It takes away the complexity of selecting specific companies to invest in and rides the general growth of all business within the index. In other words, the fund invests your money into all the companies in that index based on the weightage that each company holds in the index. It is assumed that fund managers who manage mutual funds are smart enough to know which companies to invest in and which ones to avoid. However historical data suggests that over a long period of 10 years or more, there is little to chose. Very few active funds will have beaten the index. While some active funds will beat the index, the question is which ones?
Another important reason to invest in an Index fund is the
diversification it provides across various industries, companies and business
cycles. Remember that an index itself is a self correcting one. Over the
period, poorly performing companies will be eliminated from the index while
well performing companies get added. This provides a vast diversification of
the fund.
The most important advantage of an index fund is the low cost. Investing in an actively managed mutual may entail an annual cost of 1% to 2% which is taken from your investment fund. In other words, the fund house will deduct that amount each year from your fund. This is referred to as the Total Expense Ratio (TER). Now imagine the impact of this on your investment compared to the TER of an index fund which may vary form 0.15% to 0.3%. This has a huge impact on the total outcome say at the end of 15 or 20 years.
 |
| Size Matters Click here |
No comments:
Post a Comment