Investing in Index Funds

Index investing or trading can be simple or enormously complex, depending on how you approach it and what you expect out of it. Simply put, an index is a type of indicator that shows how a particular group of stocks are going. For example, the most well-known index, the Dow Jones Industrial Average, tracks the price of 30 blue chip stocks taken together as an aggregate, and averaged and weighted. The Dow covers most areas of the economy, and is seen as a major indicator of the market.

If you want to invest in the "Dow", you can purchase shares of each of the 30 companies represented, or you can purchase an exchange-traded index fund that does it for you. One such fund is called Dow Industrial Diamonds, and is traded on the AMEX under the ticker symbol DIA. This represents perhaps one of the simplest ways to engage in index trading: Simply buy shares of DIA, and let the fund do the heavy lifting work for you. There are exchange-traded funds that track other indexes as well.

An index fund is a type of mutual fund. It typically has lower administration fees than other mutual funds, since management of it does not require as much decision-making. The manager of the DIA, for example, doesn't have to decide which stocks to buy; the fund buys all 30 of the Dow, in a certain predetermined proportion, and that's it. If you're concerned about "beating the market," long-term index fund holdings aren't for you, since that represents the market itself that the others are trying to beat. Having said that, realizing that most mutual funds don't beat the market, index funds are a wise investment for long-term holdings.

The Standard & Poor's 500 Index is perhaps an even better indicator of the "market," since it includes 500 different large-cap stocks, as opposed to the Dow's 30. Many fund managers peg their performance against the S&P 500. The Russell 2000 Index tracks small cap stocks that aren't usually part of the major indexes; the Wilshire 5000 tracks over 6,500 stocks that cover a wide variety of industries and companies across multiple exchanges; and the Nasdaq Composite Index represents all the stocks traded on the Nasdaq.

You can also dabble in foreign stock markets easily by buying into index funds that track foreign stock exchanges, such as the UK's FTSE (pronounced "footsie") 100, Hong Kong's Hang Seng index, Japan's Nikkei, and Germany's DAX.

In general, investing in index funds compared to investing in individual stocks, is a fairly steady and more secure investment, which has historically gained over the long run at a good rate. In a bear market it will go down, but when held long-term, your value will likely increase.

Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.