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Veteran business correspondent Karen Gibbs answers your personal money questions and addresses current topics that affect YOUR finances on a daily basis. Karen is the financial expert in your corner--no question is too basic or too small. Karen boils down the issues simply: here's what you need to know, and here's what you need to do. Send your money questions to AskKaren@mpt.org and post your comments below.

27

April

The 411 on Index Funds

Karen Gibbs

Karen, what is an index fund?

- Kevin, Randallstown

 
Charts and CalculatorsKevin, an index fund is a type of mutual fund.  A mutual fund is a fund that pools your money with other investor’s money to get economies of scale.  You get the benefit of diversification for a fraction of the cost and none of the management worries.


An index fund is a fund that tracks or mirrors the movement of an underlying asset; it could be bonds, gold, oil or one of the major stock market indices.  This form of investing is called “passive” investing as you don’t do anything; the index does all the work.  


Index investing has exploded over the past decade as more investors sock away retirement funds with companies such as Fidelity and Vanguard.  Index investing recently has outperformed “active investing”, funds investing in a basket of assets determined by an active manager – one that picks stocks, bonds and other assets according to a proprietary model.  Index investing is also cheaper than investing in an actively managed fund.  Latest data show an average cost for mutual fund of 0.17%.  Contrast that to the average cost of an actively managed fund of 1.32%.


Index funds can track a major index such as the S&P 500 index, a high quality U.S. bond index such as Barclay’s Capital Aggregate Bond Index, or mirror the price movements of popular commodities such as gold or crude oil.


Your index fund could be a mutual fund whose price is determined only at the close of business when the net asset value (NAV) is determined or it could be an exchange-traded fund (ETF) which trades throughout the day similar to a stock.  


If you invest in an employer-sponsored retirement plan, you most likely invest in a traditional mutual fund.  If you invest through a brokerage account, you have the option of using exchange-traded funds instead of mutual funds where fees are lower.   ETFs are preferred if you are making a large, one-time investment and pay your broker just one fee for that transaction.  If you are making repeated investments regularly, you’re better off with a mutual fund that doesn’t charge transaction fees, but does charge management fees.  There are tax savings as well associated with ETFs, but you should talk to your accountant or tax preparer to determine the effect on your bottom line and investment goals.  


Index funds, along with mutual funds and actively managed funds may all have a place in your investment portfolio.  Its smart thinking about your money to talk with a certified financial planner, assess where you are financially now and where you want to be financially ten, fifteen even twenty years from now.
Having a plan, supported by the proper investment vehicles, is one way to ensure financial independence.


Good luck!

-Karen

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