Investing your money in stocks is one of the most effective ways to grow wealth. But what if you’re clueless about the stock market? What if you have no idea how to evaluate companies and figure out which ones to buy? While there are resources available that can guide you through the process as a first-timer, there may be an easier way to put your money to work — buy index funds.
How index funds work
Index funds are passively managed funds that aim to match the performance of the market indexes they’re tied to. An S&P 500 index fund, for example, will have the goal of mimicking the performance of the S&P 500 itself.
By comparison, actively managed mutual funds don’t aim to match different indexes; they try to outperform them. And with actively managed funds, professionals are hired (and paid handsomely, much of the time) to hand-pick investments. The result? Actively managed mutual funds charge higher fees than index funds. (Interestingly enough, though, they don’t always outperform them.)
Benefits of index funds
Low fees are one advantage to putting your money into index funds. But also, index funds make it easy to build a diverse portfolio. If you own shares of an S&P 500 index fund, you’re effectively investing in 500 different stocks. When you hand-pick stocks, you need to make sure you’re targeting different market segments. That takes time and effort you may not have.
So what’s the downside?
Index funds are an easy way to invest. But when it comes to growing your wealth, do you really want to take the easy way out? Maybe you do, and that’s fine. But with index funds, you won’t beat the market. To do that, you’ll need to assemble your own portfolio, and that requires research galore.
Index funds also don’t give you any control over your investment mix. Sure, you can choose which specific index funds to buy, but beyond that, it’s out of your hands. To be fair, though, the same holds true with actively managed mutual funds. Unless you’re one of the advisors who chooses investments for a given fund, you get no say in what goes in and what doesn’t. But if you have a particular problem with certain types of stocks â€“ say, tobacco stocks — you could get stuck owning them anyway.
If you’re contemplating putting money into index funds, ask yourself what your priorities are as an investor. If you want to grow wealth easily and efficiently without doing a lot of work, then index funds are a good choice. If you want your portfolio to outperform the broader market, they’re not.
Start with index funds and go from there
If you’re new to investing, there’s nothing wrong with taking the easy way out for now, ramping up your knowledge, and buying individual stocks down the line. In the near term, though, you can choose an index fund like the Vanguard S&P 500 Index Fund (NYSEMKT: VOO) to get started. That way, you won’t delay putting your money to work.
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