Index Investing For Dummies

Exchange Traded Funds (ETFs) are the rage today with many investors flocking to purchase them as opposed to the usual mutual funds. ETFs work in this way. The fund manager decides that he wants to mimick the returns of the NASDAQ, so he buys all the stocks that make up the index and then he sells shares in this fund to investors. This means that you have effectively diversified your risk when compared to another investor who buys and individual share. There are three related reasons why there has been an upsurge in recent years in the number of fund managers setting up these funds.

Low Cost

The first reason would be the relatively low cost that works both ways. Since we are not stock picking, the fund manager needs just to set up software to ensure that the fund accurately mimics the stock holdings of the index. Some shares have a greater representation in the index than others by virtue of their large clout and number of shares issued in the market, and the fund has to respond to that.

The other way the cost factor kicks in is that many investors today are happy and delighted to find an investment option that is cheap regarding fees. Since the fund manager does very little monitoring or research for this fund, it’s cheap to purchase this monthly, and this makes a very good investment for the retail investor.

Defensive Investing

Benjamin Graham the value investing guru advocated the concept of defensive investing in an Exchange Traded Fund in his book The Intelligent Investor. In that book, he did back calculations back to the days of the Great Depression, and if you invested monthly since then, your average return would be 33% on average. It’s not bad because you did not have to spend time wondering whether the index was up or down or whether your latest stock pick was in the money or not. Buy a small amount monthly whether the stock market is up or down and use it as a rainy day fund that you can rapidly liquidate for ready cash. The reason why this is called defensive investing is that you do not have to spend time actively picking and most investors whether professional or retail lose money actively picking stocks and ETFs remedy this problem by sure probability and mathematical statistics.

Plurality of Options

ETFs today is flooding the market with each of the top fund houses setting up new and more fanciful financial baskets each day. Today there is a significant plurality of funds that you can purchase from Tech ETFs to Banking ETFs to Energy ETFs and so you have no shortage of options. If you are optimistic on a certain sector and do not want to waste your energy and time picking the right company actively, ETFs with their current plurality of options is the high key to diversified investing in a particular sector. The time saved scrutinizing financial data which is often padded up is not worth the effort sometimes when there is a tremendous intrinsic fraud.

In conclusion, ETFs today represent a cheap, effective way for you to do defensive investing and with that part of your money relatively secured, you can then spend some of your money doing active stock picking if you are so inclined. Take some effort this week to research into this financial instrument, and you may find the returns better than your fund manager in the longer term (when averaged over time by statistical probability).

Charles Mao is author of the article. He is a professional financial blogger and trader at stock predictor service. He has been lucky enough to work for the famous economics magazine. Charles is from Los Angeles.

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