Index funds are a type of exchange-traded fund (ETF) or mutual fund that holds all the securities in a specific index. Over the last few years, index funds have become a major force among investors who seek passive index strategies instead of active management. There are several reasons why index funds have become popular over the years. Not only are they usually cheaper than the alternatives, but they also come with lower taxes too.
One of the most well-known indexes is the S&P 500. However, this is not the only option available to investors. In fact, there are many other indexes and index funds for investors to choose from. The truth is that there is an index fund for nearly every investment strategy and market you can think of.
However, before you choose to invest your money in index funds, it is important to do some research into the different types of index funds available. For example, not all index funds will be low cost and not all index funds are particularly good at tracking the market. Not only that but owning an index fund does not mean you are immune from losses or risks if the markets take a downturn.
One of the most recent downturns we have seen in the market was caused by the coronavirus pandemic. This stock market crash, also known as the Coronavirus Correction or the Coronavirus Crash was a rapid global stock market crash that started in February 2020. The crash signalled the start of the COVID-19 recession. This crash has led to many people worrying whether it is safe to invest in index funds or other types of funds in 2021. If you want to know more about index funds and whether you should consider investing in them in 2021 then keep reading below:
The Benefits of Investing in Index Funds
There are several benefits to index funds. Not only do they have lower management fees, but they can also be purchased from a range of providers e.g., directly from an index funds provider or they can be brought through a brokerage.
Index funds have regularly beaten other types of funds in terms of total returns. A major reason for this is because the management fees of index funds are much lower than other funds. Index funds are passively managed. This means that instead of having a research team making recommendations and analysing securities and a manager actively trading, the index funds portfolio simply duplicates that of its designated index. This means that less money is being spent on wages. Another reason index funds are cheaper is because they hold their value until the index changes. This often takes a long time to happen so the transaction costs are lower. These lower costs can have a huge impact on your returns, particularly in the long term.
An additional benefit of index funds is that they produce less taxable income compared to other investment funds. But this is not their only tax advantage. Investors can also choose to sell their index funds with the lowest capital gains, this reduces the amount of tax that investors must pay.
The Disadvantages of Index Funds
Lots of people choose to invest their money in index funds and we can see why. Index funds at their greatest offer a low-cost way for investors to track popular bond and stock market indexes. Not only that, but most index funds also outperform most actively managed mutual funds.
However, while investing in index funds may seem like a brilliant idea, there are some things you need to understand about index funds before you invest all your hard-earned cash. Here are some things you should consider when planning your investment strategy:
- Index funds are not created equal – There is a huge range of low-cost index funds and ETF’s for investors to choose from. However, they are not all the same. Some index funds have underlying indexes that were essentially produced in a lab with results that are largely back tested. While this is a legal and valid analytical tool, investors should be wary of index funds that consist of large amounts of back testing. It is much better to choose index funds or ETF’s that track real market data.
- Index funds are not all cheap – It is important to compare different index funds before choosing one to invest your money in. This will allow you to make the best choices. The advantages of choosing a low-cost index fund over a high-cost active fund can be significant.
- Index funds can be risky – While investing in index funds is often seen as a less risky option, investors need to be aware that investing in index funds still comes with some risks. In fact, if we look at what happened to the S&P 500 in 2008, we can see that investors lost roughly 37% plus the fund’s expenses. This was because of the sharp decline in the underlying index. However, while index funds do come with some risks, they are much less risky than actively managed funds. This is because they eliminate manager risk.
- Underlying indexes can change – investors need to keep an eye on their index funds so that they can spot any changes in the indexes. This will help to prevent them from suffering large losses.
- They do not guarantee investment success – simply investing in an index fund doesn’t guarantee you to earn money and reach your financial planning goals. Just like any other investment product, index funds are tools. If you want to get the most out of your index funds, you will need to know how to use these tools properly. Not only that, but you will also need to have a strategy.
How to Invest in an Index Fund
If you want to invest in index funds, then here are some steps you need to follow:
- Choose a brokerage – once you have found a brokerage you will need to open a brokerage account. You will then need to add funds to this account.
- Find an index fund you believe in – while many first-time investors are tempted to simply invest their money in a well-known and popular index fund without doing any research, it is advisable to do some research into the different options available to you before choosing one that suits your wants and needs. However, if you like the idea of investing in a safer and cheaper index fund then investing in the S&P 500 is usually a great place to start.
- Slow and steady wins the race – if your portfolio is exciting, it is likely to be risky too. Although index funds are a relatively safe option, they do come with some risks, so it is important not to invest more than you can afford to lose. Investors should start by investing only small amounts of money. This can then be increased over time. This is a solid strategy for building up an index portfolio from zero even during a market downturn.
If you want more information on investing in index funds Canada, then check out this article from Wealthsimple. This company offers simple investing opportunities, without the account minimums and high fees associated with traditional investment management. Not only that, but their low-cost funds, diversified portfolio, and the cutting-edge technology they use will also help you to earn the best possible returns on your investment.
Should You Buy Index Funds in 2021?
The coronavirus pandemic has devastated several industries around the world, such as cruises and air travel. This has led to a downturn in the stock market. Thankfully, it looks like there’s light at the end of the tunnel. Several vaccines have now been approved in several countries around the world. This end means that we can cautiously start looking towards post-pandemic investing.
As we mentioned above, there’re a few important rules you should follow when it comes to investing money. These rules are even more crucial for investors wanting to invest in index funds in 2021. One of the most important rules is to invest your money slowly. Start by making small investments that you can afford to lose should the markets take a further downturn.
When it comes to choosing the right type of investment to make in 2021, index funds are a brilliant option. If we look at and compare the history of index funds to actively managed funds, index funds outperform actively managed funds approximately 80% of the time. It is important to remember that the current situation we are in is only temporary. While index funds may not be performing quite as well as they were a couple of years ago, evidence suggests that this will soon change, and you are much more likely to get a good return from your investment if you invest in the stock market. Investors need to remember that they are investing for the long term and they should only invest money that they will not need for the next few years.
Investing in index funds is a brilliant low-cost strategy for part or all of your investment portfolio. Like most other investment strategies, investing in index funds requires you to do some research and understand what you are investing in. It is important to remember that not all index fund products are the same, so you will need to look at more than the index fund label to make sure that you are truly choosing a good product.