Index funds offer low-cost, diversified investment options that track broad market benchmarks, such as the S&P 500 or FTSE 100. By spreading investments across different types of securities, risk is shared across multiple categories, potentially providing exposure to more than one asset class.
One investment style involves asset allocation in index funds. These are portfolios that can be managed by professionals but do not change frequently. The purpose of such a fund is to function as another market benchmark. A diversification index is one in which there can be exposure across different types of financial securities. Consequently, if one asset class or investment category falters, there is a greater chance that another will continue to generate gains.
In financial markets, there are broad benchmark funds that reflect the overall performance of stocks. For example, in the US, the Standard and Poor’s (S&P) 500 Index contains some of the largest listed equity securities. In the UK, the Financial Times Stock Exchange (FTSE) 100 Index consists of the largest stocks listed on the London Stock Exchange. These indices are not limited to a certain sector. Instead, the companies that are included in both funds meet size standards, based on a measure known as market capitalization, as well as regional requirements.
Major stock exchanges and investment firms create such indices to illustrate performance in the broad financial markets. Investment managers who oversee portfolios that mimic trading in broader markets are giving clients the opportunity to buy on a diversified index. Fund managers try to replicate the performance of regional funds by building their own portfolios that are composed similar to the market barometer. Investors can generally expect a return that is in line with the benchmark.
One of the main benefits of index investing is the cost. Money managers can usually keep the expenses of these funds relatively low, since only infrequent trades occur. The financial advantage is typically passed on to diversified index investors, who get the experience of professional money management without paying excessive fees.
Diversification is another generally positive approach to investing. When a person saves for a major event, such as retirement, they become vulnerable to the unpredictable fluctuations that often occur in financial markets. By spreading money across different types of securities, risk is shared across multiple categories. A diversification index can help someone achieve the appropriate risk.
Another possible reward for using a diversification index is the potential exposure to more than one asset class. For example, in a balanced fund, an investor may be exposed to both stocks and bonds. If equity markets underperform over a period of time, a portfolio could still meet expectations based on the income the bonds generate.
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