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Investing 101: What is an Index Fund?

Get a broad selection of stocks with a single purchase

February 6, 2013
The Intelligencer / Wheeling News-Register

When you invest in the stock market, you have a number of choices available. You could invest in individual stocks, although that option can be quite risky for individual investors. You could invest in managed mutual funds, but you could face high costs, and in some cases substandard performance as well.

Your third option is to invest in an index fund. With an index fund, you do not try to beat the market or time the appearance of the next bull or bear market.

Instead, an index fund simply buys and holds all of the stocks in a given index. That strategy makes the index fund perform in line with the overall stock market, going up when the market goes up and down when it falls.

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While index funds are not very exciting, they can be a smart way to invest. One of the most important, yet often overlooked, advantages of an index fund is that these funds tend to have very low expenses.

For instance, one large index mutual fund charges an expense ratio of just 0.18 percent. That means that an investor with $10,000 in the market would pay just $18 in expenses over the course of a year.

When you compare that to the 1-2 percent expense ratios common on many managed funds, it is easy to see how an index fund can save you money.

Index funds also tend to be very tax efficient. Saving money on your taxes is very important, since every dollar you save in taxes is one more dollar you get to invest for the long term. Over many years the value of that extra dollar can add up to hundreds of dollars.

If you think an index fund is right for you, just contact several mutual fund companies or local investment advisors and ask for a prospectus.

Although the costs associated with index funds are typically quite low, they do vary from firm to firm. Weighing both the costs of a fund and its long-term track record can help you keep more of your money.

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