Background:
To invest, there are many options you can pick. First, you can decide to do any of the financial markets. Of them is the stock market. Indeed, picking stocks yourself is a viable way to invest. But do you have the expertise? You are not any Warren Buffett.
The good news is that even if you do not have the knowledge and skills, there are proxies that can help you invest in the stock market. Index funds and exchange-traded funds (ETFs) are ready examples.
Index Funds
“A low-cost index fund is the most sensible equity investment for the majority of investors. My mentor, Ben Graham, took this position many years ago, and everything I have seen convinces me of its truth.” – Warren Buffett.
Generally, index funds are a type of mutual funds. They are designed to track the performances of market indexes (hence their name) the most popular of which are the S&P 500 and the Dow Jones Industrial Average (DJIA) 30. Every financial market has an index. And with index funds, investors do not need to buy individual stocks themselves.
Stock Index.
Instead, professionals, known as fund managers, pick the component stocks of the indexes, time the market to enter positions on them, and then manage them on behalf of the investors. With those stocks, the performances of the indexes can then be mimicked. As a result, index funds change only when the indexes they are benchmarked against change.
Because they hold a basket of stocks, index funds are well diversified. Also, they attract low costs. And given the historical average stock market return of 10% every year, index funds, by matching market risks and returns, tend to be solid long-term investments, making them the perfect investment vehicle for retirement accounts.
ETFs
“ETF portfolios will be the inevitable default for investors in the years to come because they are lower cost, more transparent, and offer greater liquidity and tax advantages than mutual funds.” – Jon Stein.
Exchange-traded funds, ETFs for short, are investment products traded on stock exchanges (hence the name) much like stocks themselves. However, an exchange-traded fund can also be a collection of other assets such as bonds, commodities, or a mixture of them.
ETFs are created this way: a fund provider buys the underlying assets, groups them together in the fund which is listed on an exchange, and then sells units of them to the investing public. ETFs are listed under unique ticker symbols for monitoring their price activity and are designed to track the performances of market indexes such as the S&P 500.
Although lesser-known, ETFs are similar to mutual funds. Both provide a diversification advantage and are professionally managed. However, relative to mutual funds, ETFs are cheaper, more transparent and more tax-efficient, features that have expectedly given them a greater appeal.
How to Invest in Index Funds and ETFs
There are many ways to invest in index funds and ETFs and each depends on the amount of time you are willing to commit to monitoring your investments. If you will be a hands-off investor, for example, a robo-advisor is the way to go.
However, for active investors who are interested in committing fully to actively managing their funds, online brokerage firms are best advised. The good news is that the two products are already standard offerings by them.