Basics Of Index Funds

Posted: 13 Feb 2008 | Categories: Stocks Mutual Funds

Index funds can be simply explained as mutual funds that aim to replicate the movements or else copy the performance of an index belonging to a specific financial market. Different indices copied for index funds include S&P500, Russell 2000, Wilshire 5000, MCSI-EAFE, Lehman-Brothers Aggregate Bond and NASDAQ 100.

Index funds are ideal investment vehicles for those investors who are more interested in buying and holding their investments, thereby allowing them to grow. These funds are advantageous in way that they carry very low fees primarily because they lack any active management. These funds need not invest anything on hiring an expensive fund manager or any research analyst for managing the funds. In most cases, computers are programmed to handle the job of fund management. Even the expense ratio on index funds is as low as 0.18 percent. Another advantage of these funds is that it is easy to understand the objectives and asset allocations of the funds. One can easily determine the securities a fund will hold depending upon the target index.

As per law, buying and selling of trades is taxable. As a result, mutual funds need to pay out capital gains and dividends every year. Hence, these funds do not enjoy any type of tax rebate. On the contrary, index funds belong to a special category of mutual funds that enjoy tax benefits. These funds have the advantage of delaying capital funds due to the reason that the funds hold on to a particular stock for an extender period of time, unlike all other types of mutual funds. This means that the money saved in the form of taxes keeps on generating returns. However, an average turnover on a fund is relatively low when compared with actively managed funds.

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