Index Investing StrategyA index investing strategy involves buying an index fund. Instead of purchasing individual stocks, you simply buy into a fund that contains all the stocks within a stock market index.Let’s consider index investing strategy . . . Why index investing worksStock markets go up more than they go down. The average length of a bull marketA bull market is characterized by positive investor sentiment, and rising share prices. exceeds the length of the average bear marketA bear market is characterized by negative investor sentiment, and falling share prices. by a large proportion.So it becomes obvious that overall stock markets go up on a long-term basis. By buying into an index fund, over time you will achieve the same return as the index. An index fund has the advantage of diversification which reduces the risk to the investor. For people with no inclination to individual stock analysis, an index investing strategy is a good investment choice. Tactics of index investing
Advantages of index investingYou don’t have to pick individual stocks. You just buy into a fund.The funds are very diversified. An index fund can be part of your diversification strategy. An index fund may provide tax advantages because of the long-term (greater than 12 months) nature of the investment. Investments that are sold within 12 months of the initial purchase attract higher tax rates in some countries. Some index funds give you the option of making regular contributions without expensive brokerage fees. This is an excellent investment strategy. These additional contributions that you regularly feed into the fund will make a very significant difference to the amount of money you will receive when you eventually sell your stake in the fund. To see the dynamics of this concept in action check out the Investment Results Calculator. Click on the “Calculate” button and then see what results are returned. In particular, notice how much money you will earn at the end of the 10 year period. Then adjust the “Annual Savings Added” field to a larger value, say $20,000 (note: don’t enter a dollar sign ($), or comma just 20000). Notice how much higher the return is at the end of the 10 year period. You might want repeat this exercise with a more suitable interest rate. By default, the interest rate is set to 20%. 10% to 12% would probably be more consistent with the returns you would expect to receive from an index fund. Disadvantages of index investingYour returns will mimic the performance of the overall index minus a small management fee.Index funds are a long-term investment strategy (this is also an advantage depending on your perspective). A passively managed index investing strategy will not earn the higher returns experienced by some of the other strategies listed below. Who uses index investing as a strategy?I don’t know of any famous investor who uses an index investing strategy, however, it is an excellent option for a risk averse investor, and people with no inclination towards individual stock selection and portfolio management.Fundamental Analysis – the company’s financial numbers and its story Technical analysis – examining stock charts and technical indicators Value Investing – buying good companies at the right time Growth investing – buying companies that are growing fast Income investing – buying companies for their dividends Index investing – buying into a stock market index fund |