Index Funds and Exchange Traded Fund (ETFs)
Buying and holding a stock in a particular company always has some form of risk involved. One of the biggest risks is that the investment relies on the performance of the company for it to gain profits. Should the company perform poorly financially, suffer from negative press, or other events that will harm them, their investors may lose value in their stock investment. One way to mitigate these risks would be to diversify the investor’s portfolio by buying other stocks to balance out any potential losses that may come from investing. However, this will cost more in terms of transaction/commission fees and varying prices of each stock makes some of the stocks not affordable to many investors. How can an investor diversify their portfolio while avoiding any extra costs/paying for expensive stocks? They can instead trade in Index Funds or Exchange Traded Funds (ETFs)
Index funds are described as a basket of stocks, bonds, or other securities that is used to represent the performance of a market segment or index. They may only be bought/sold after the stock market is closed.
ETFs are almost identical to Index Funds but with a key difference; they can be day-traded like a regular stock. In fact, some ETFs are used to track indexes the same way that index funds do, making them more valuable for active investors.
Examples of Index Funds/ETFs:
Fidelity 500 Index Fund (FXAIX)
SPDR S&P 500 ETF (SPY)
SPDR Dow Jones Industrial Average (DIA)
Invesco QQQ Trust (QQQ)
Index funds/ETFs are diversified. they rely more on the performance of multiple stocks/securities instead of just one stock.
In terms of transaction fees, Index Funds and ETFs charge less than if the investor were to buy multiple stocks for their portfolio
Index funds/ETFs track the current state of the market in their respective fields. One can make a more informed decision when purchasing a stock based on the index funds’ current movements
ETFs can be day-traded like regular stocks allowing you to profit/exit from a position at any time
Some Index Funds/ETFs are cheaper than the stocks that are included in them
Some Index Funds do not require a minimum investment, investors can therefore invest with whatever amount of funds they have
Index funds/ETFs are not immune to market conditions that may affect a large quantity of companies (Example: The recent COVID-19 virus that cause almost every stock in the indexes to drop more than 5% in value)
Some index funds require a minimum investment, with some minimums being as high as $10,000
Some of the best ETFs in the market are expensive
Index funds can only be bought or sold at the end of the trading day; they cannot be day traded
Index funds/ETFs are not flexible compared to building your own investment portfolio from the stocks you choose. An index fund/ETF may also contain stock(s) that you dislike.
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