What are Index Funds?

Index funds are typically a type of mutual fund or exchange traded fund that is set up not to generate a huge profit but to mimic the average market returns. An index fund is a collective investment scheme that tries to copy the movement of a specific market and to make the return constant. Therefore, in times of either stock market highs or lows an index fund aims to be content in the middle of the road.

Index funds are passively managed accounts that is set up by statistical information and not actively coddled and manipulated by a market manager. Because of the hands off approach of index funds, the fees associated with investing in them tend to be lower then their actively hands on managed cousins.

For those whose goal is to avoid extreme volatility, an index fund may be a possible choice. The goal behind index funds is to stay constant regardless of fluctuations in the market place. There are approximately 1000 index funds listed in the Morningstar database and not all of them follow a well-known index.

The biggest setback to index funds comes in the appearance of a “tracking error.” Since the ultimate goal of an index fund is to be constant, to average any under performance or over performance is considered an error. Those errors may lead to the negative investment.

Index funds have a very admirable goal, but are not immune to the volatility of the market. There are still risks involved with index funds, that is why unpredicted changes in the market could have great negative impact to an investor’s index fund investment. Before considering moving your money into an index fund or any other investment, it is important do your homework first.