Index Funds

 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. 

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 active 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 choose. Very few active funds will have beaten the index. While some active funds will beat the index, the question is which ones? 

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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 from 0.15% to 0.3%. This has a huge impact on the total outcome say at the end of 15 or 20 years. Read about the value of 1% here.

In summary, index funds are an excellent route to building wealth over the long term. Could other active funds beat the index funds? Sure. A few will. Alas if only we have that crystal ball to know which ones! 

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