5 Benefits of Buying Low Cost Index Funds

Whether you’re getting started with investing in the stock market or you’re a seasoned investor on the lookout for a great way to build wealth, you can’t go wrong with a low-cost index fund. Those are funds that basically mimic one of the major stock market indices (the S&P 500, the Dow Jones Industrial Average, or the NASDAQ composite).

Here are 5 benefits of buying low-cost index funds

1. Automatic Diversification

By definition, an index fund is diversified. You don’t even have to invest in one of the best index funds to benefit from diversification, because they’re all diversified by default.

An S&P 500 index fund, for example, will mimic the movement of the S&P 500 index. That index is comprised of 500 stocks. You can’t get much more diverse than 500 stocks.

A Dow index fund will move in tandem with the Dow Jones Industrial Average. That index has 30 stocks.

If diversification is what you’re looking for, an index fund is what you want.

2. Low Operating Expenses

If you have trouble understanding mutual funds then you should know, at a minimum, that they have operating expenses. Mutual fund companies aren’t charities, after all.

However, index funds tend to have lower operating costs as compared with funds that are actively managed. That’s because there is no “manager” of the fund who’s always out looking for the next Amazon or Netflix. Instead, the portfolio is allocated according to the index. It’s on autopilot.

3. Low Trading Expenses

It’s often the case that actively managed funds buy and sell stocks frequently. That adds up in terms of commission as well as your capital gains tax responsibility.

However, index funds track the major indices. They don’t buy and sell stocks unless there’s a change to the index. While the composition of stocks in an index is known to change from time to time, it’s not typically as often as with funds that are actively managed

4. A Mix of Asset Classes

Because index funds are comprised of stocks in an index, they have a healthy mix of asset classes. They’ll contain stocks that are part of the financial, tech, pharmaceutical, durable goods, and other sectors. That means you have diversity across sectors as well as across individual companies.

On the other hand, a manager of an actively managed fund might be tempted to chase a few stocks of a particular asset class just because he or she thinks they’re “hot” right now. That could lead to an imbalance in a particular asset class that could increase your risk exposure if a specific industry takes a hit.

5. You Will Probably Get Above Average Returns

Mutual fund companies are littered with mutual fund managers whose funds don’t perform as well as the S&P 500 or one of the other major indices.

You won’t have to worry about that if you buy into an index fund. By definition, you’ll do just as well as the index you’re tracking

One of the smartest moves you can make if you want to just “buy it and forget it” is to buy an index fund. That’s because the costs are low and the historical performance is great.