There are plenty of ways to invest your money to grow wealth over time. Some of the more popular channels include real estate, stocks, and mutual funds.
But another lesser-known investment vehicle to consider are index funds. What exactly are they, and are index funds something you should consider investing into?
Check out our guide on investing for beginners.
What is an Index Fund?
An index fund is a type of mutual fund or exchange-traded fund (ETF) designed to mimic a financial market index. They contain a small portion of the companies included in a specific market index. As such, you’re basically purchasing a small part of the entire market when you buy an index fund.
Since your money is spread across several companies within an index, you can effectively diversify your portfolio rather than focusing on a small number of stocks. This can help to hedge against risk. Furthermore, there’s little need to be concerned about beating the market or choosing “winning” stocks that will outperform the annual growth of the market.
This type of investment allows investors to take a more passive approach to investing but with lower costs than an actively managed fund. Index funds follow specific preset rules in order for the fund to be able to accurately track a particular basket of investments.
Types of Benchmark Indexes
Some of the more common benchmarks indexes include the following:
S&P 500. The Standard & Poor’s 500 (S&P 500) is a stock market index that tracks the performance of 500 large companies listed on US stock exchanges.
Dow Jones Industrial Average. This index measures the performance of the 30 largest firms listed on US stock exchanges.
NASDAQ. The NASDAQ Composite is a New York-based stock exchange that tracks over 3,000 tech-based firms. It is ranked second behind the New York Stock Exchange (NYSE) in terms of market capitalization of shares traded.
Russell 2000 Index. This index measures the performance of the smallest 2,000 stocks — also referred to as “small cap” companies — with market capitalization of no more than $2 billion).
Wilshire 5000 Total Market Index. This index tracks close to 7,000 publicly-traded American companies and is considered the broadest stock market index of publicly traded US firms.
MSCI EAFE Index. Large- and mid-cap stocks of companies based in 21 developed countries outside Canada and the US — including those in Europe, Australasia, and the Far East — are tracked by the MSCI EAFE Index.
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Popular Canadian Index Funds
While there are several index funds to choose from, Canadian investors may find the following popular Candian index funds appealing:
TD Canadian Index – e (TDB900). Issued by TD Asset Management Inc Assets Under Management (AUM), the TD Canadian Index tracks the performance of a widespread Canadian equity market index. It can provide long-term capital growth by measuring the investment return of Canadian securities that are publicly traded.
CIBC Canadian Index (CIB300). This index fund invests mainly in securities that are part of the S&P/TSX Composite Index, reflecting the Canadian equity market on the Toronto Stock Exchange. Its asset allocation is focused on the financial sector, though other industrial sectors are included as well.
Want to invest in real estate? Consider Real Estate Investment Trusts (REITs).
Scotia Canadian Index Fund (BNS181). This Canadian index fund invests predominantly in the stocks that are part of the S&P/TSX Composite Index and tracks that index. The index fund also invests heavily in the financial sector, including in RBC and TD Bank. Scotia Asset Management Assets Under Management (AUM) is the index fund’s issuer.
RBC Canadian Index Fund (RBF556). Issued by the RBC Global Asset Management Inc. Assets Under Management (AUM), this index fund invests mainly in equity securities of firms in Canada in order to measure the S&P/TSX Capped Composite Total Return Index.
Don’t know if you should invest in a TFSA or an RRSP? Find out the difference between a TFSA and an RRSP.
Pros and Cons of Investing in Index Funds
There are several perks to investing in index funds, but there are also some drawbacks to consider as well. Be sure to weigh the pros and cons prior to investing.
Pros:
- Lower management fees. Index funds are typically more affordable than traditional mutual funds. There are no active management fees to pay, and trade commissions are either very low or non-existent.
- Good diversification. You can easily lower your investment portfolio risk with built-in diversification through index funds. These investment vehicles allow you to invest a small portion in several companies represented in the market, which can minimize your risk exposure.
- Low minimum investment. You don’t need a massive amount of capital to start investing with index funds.
- Passive investing. You can easily participate in your market of choice rather than scrambling to figure out which stock to invest in that will outperform the market. Instead, index funds allow you to passively invest while allowing your investment to mirror the market rather than always trying to beat it.
Cons:
- Low rewards. Since the risk with investing in index funds is very low, so is the potential reward. Generally speaking, reward potential increases with a higher risk. This type of investing is more on the conservative side, which means that even though you will build wealth over time, it may not happen as quickly as it could with a more aggressive investment approach.
- Low liquidity. Investing in index funds is a long-term investment strategy. When you invest this way, you go in with an understanding that your money will be tied up for the long haul. Investors looking for quick returns after a short period of time may want to consider other investment vehicles.
- Less control. Index funds are great for those who like the idea of a set-it-and-forget-it type of investment. But those who seek more control over their investments may find index funds frustrating, as being tied to a specific index may feel restrictive.
Additional Reading
FAQs About Index Funds
Where can I buy an index fund?
What’s the difference between an index fund and a mutual fund?
Why do index funds have low fees?
Final Thoughts
If you are looking for a low-risk, passive investment strategy that will help you steadily build wealth over time, then index funds may be right for you. Speak with your investment broker to determine which index fund to park your capital in.
