Index funds - a self-propelled investment
In this post, we will take a closer look index funds. What is an index fund? How does an index fund work? And how do they differ from an equity fund?
By Viktor, co-founder of Bifrost - Feb 7 2019
What is an index?
Before we dig ourselves deep into different types of index funds, we must understand the concept. What is an index? An index is a list of several financial instruments, such as shares, fixed income securities, currencies, etc. The index aims to show the aggregated price movement of the instruments included in the index. One of the more common indices in the UK is The Financial Times Stock Exchange, FTSE 100, which includes the 100 most valued companies on the London Stock Exchange.
How does an index fund work?
An index fund aims to develop in line with the index it follows. An index fund for the FTSE100, for example, will yield the same return as the index's movements. However, minus the low management fees. There are a lot of stories about how an investment on the stock exchange in general beats any other forms of saving. And that the stock market tends to rise in the long term. One can see investment in an index fund as just that - an investment in the stock exchange. There are, after all, a quite large number of stories about fund managers who in the long run never performs better than the Stock market. So, a long-term investment in an index fund may be a good idea!
How does an index fund differ from an equity fund?
If you compare an index fund with an equity fund, there is a concrete difference. An equity fund is actively managed by buying and selling assets. The purpose is to beat the index and to give as high a return as possible to the risk the fund owner wants to take. An index fund is not actively managed but simply sits on the index shares in wet and dry. The purpose here is, as stated, to give the fund owner the same return as the index it mirrors.
Index Fund as part of the portfolio
An index fund is suitable for anyone who wants to invest in the stock market without actively managing a portfolio. However, there are more fun funds to invest in for those who do not want to work actively with the portfolio. But the index fund can also reduce individual companies' unexpected price declines by diluting these among the other companies.
Next week we’ll take a closer look at different index funds and some of the pros and cons.