If you bought shares of Facebook, now called Meta, back in October 2021, the stock price as of today is down by almost 60%! In contrast, the Nasdaq 100 – the tech-heavy index is down by about 30%, reflecting a reasonably lesser fall in value. Picking individual stocks that can be a part of the portfolio, may not be possible an easy task for every investor. Therefore, many market experts suggest, buying the index or index investing for retail individual investors. In index investing, the investor first chooses the index and then buys a fund that gives access to all of these index stocks.
So, what is an index fund? The index funds are passive funds with underlying companies that are representative of the index they track. Not just index funds, even exchange-traded funds (ETFs) are benchmarked to specific indices. You end up holding stocks in the same proportion as the index by investing in an index fund or any other fund that tracks the index.
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This is how they differ from active funds – You essentially avoid the funds that are managed by a fund manager by investing in index funds. In index funds, there is no place for a fund manager to choose a stock or industry, let alone allocate money between them.
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But, are the returns competitive in index funds? An index fund’s returns are identical to those of the index it is tracking. The returns in an index fund or an ETF will be largely in-line with the index returns. So, if an ETF tracks the Nifty 50, the returns in both of them will be largely the same, subject to tracking error.
In an active fund, the role of the fund manager is crucial. A bad investing call may hurt the portfolio while a good call has the potential to create alpha in the portfolio.
ETF and index investing are less volatile in nature. In a sense, index funds might be a fantastic place for beginners to begin when putting together a solid mutual fund portfolio. But keep in mind that while active funds with a fund manager managing the plan may perform better over the long term, it is also possible that they will perform worse.
Investors looking to invest in the US stock market may consider ETFs that track the three leading indices – S&P 500, Nasdaq 100 and Dow 30.
For example, if you want to buy the ETF that tracks Nasdaq 100, then QQQ ETF allows you to do so. QQQ is an exchange-traded fund (ETF) that tracks the Nasdaq 100 Index with similar weightage and allocation into stocks as that of the index. By buying QQQ ETF units, you end up taking exposure to the index itself. From the famous FAANG stocks – Facebook (Now called Meta), Amazon (AMZN), Apple (AAPL), Netflix (NFLX), and Google (GOOGL) – to other tech giants like Tesla, Microsoft, Broadcom, Cisco Systems, Adobe, Texas Instruments and many more, investing in QQQ means you end up taking exposure in the leading global companies of the tech sector.
Similarly, if you want to own the entire basket of stocks listed on the S&P 500 index, then SPDR S&P 500 ETF Trust, popularly known by the name SPY in the US stock market, is the one to buy. One of the attractive features of SPDR ETF is its low expense ratio of 0.0945%. Berkshire Hathaway, Visa and many more, the world’s best companies can be a part of your portfolio. Information Technology, Health Care and Communication Services are the top three sectors totaling about 50 percent of the S&P 500 index.
SPDR Dow Jones Industrial Average ETF Trust is the ETF if you want to take exposure in Dow 30 index stocks. Dow Jones Industrial Average (DJI), also known as the Dow 30 is a price-weighted index of 30 large-cap US equities and differs slightly from some of the other top US indices as it solely includes US-based companies.
Read More: Index investing in the stock market – What it is and how it helps investors