Top 3 Reasons to Invest in an Index Fund as a Novice Investor
Updated: Oct 7, 2022
Many articles have the headline "Our top 5 stock picks for the week" or "Top 5 growth stocks to invest in now!" Often, these articles aim at people with a good understanding of the stock market, its risks, and the money associated with it. Of course, it doesn't mean you can't invest in the market or individual stocks, but these require more research and active management. Ideally, you want to collaborate with a financial advisor to create a portfolio based on your needs and goals.
A core fund is an index fund that aims to achieve similar returns as the index tracks by mimicking any upward or downward movements of that specific index. This is considered a passive investment strategy, which is highly favorable in the long term.
Here are a few reasons why you should invest in index funds:
1. Diversification. Rather than putting all eggs in one basket, you are reducing your risk by allocating your money to different sectors and companies. The market is influenced by various macroeconomic factors, politics, and people's behavior, so there are many risk factors to consider when investing in individual stocks or sector funds. Without a financial professional to guide you with your portfolio management, you're probably exposing yourself to many risks and potentially losing more than if you had just invested in an index fund.
2. Low cost. Expense ratios, transaction costs, and redemption fees could eat up the gains on your investment. However, most index funds have low expense ratios, some as low as .01%.
3. Exposure to the broader market. As a novice investor, index funds are a great way to start investing, learn, and have exposure to different market areas. Index funds allow you to capture gains in multiple areas when the market is going up and limit your losses if any others go down. Rather than focusing on one sector, such as technology, healthcare, or energy, you can be invested in all these sectors in one fund with different allocation percentages.
For demonstration purposes, here are two index funds aiming to achieve the same returns as the S&P 500. Their allocations seem very similar, but their allocation in each sector varies by a few percentage points. Additionally, they both hold Apple, the first fund has 6.5%, and the second fund has 5% allocated to Apple. The difference may not seem significant, but it could impact the funds' performance.
Although an index fund's main objective is to achieve similar returns, which most of them do, keep in mind that there may be some slight differences in returns, sector allocations, and the composition of companies.
At Corinthian Wealth Management, we have created a fund selection process that uses a combination of fundamental and technical analysis to help diversify, provide liquidity, and deliver returns aligned with our client's investment objectives and risk tolerance.