If you qualify as an average investor, you have one major problem when investing in the stock market -- not enough money to adequately diversify your portfolio. So you buy a few shares of one stock and then a few shares of another, and as luck would have it, the two stocks you own are the only two stocks that lose money while the stock indexes all reach stratospheric levels. Index mutual funds may be the solution to your problem.
Stock Market Indexes
Much of the news you see about the stock market going up or down refers to the movement of the various stock market indexes, such as the Dow Jones Industrial Average, Standard & Poor's 100, Standard & Poor's 500, and the Russell 2000. These indexes measure the daily performance of a pre-determined basket of stocks so they are all examples of diversified portfolios, which you might have if you had millions of dollars to invest. They are indexes only and not investments themselves.
Index Mutual Funds
Index mutual funds duplicate the stock issues represented in the stock market indexes. They represent an excellent way for you to diversify your investments and match the performance of the stock market. Index mutual funds tend to have lower management and transaction fees than other mutual funds because they do not require active management; this is owing to the fact that they are only invested in the stocks of a certain index, according to the relative weighting of those stocks within the index.
The drawback to index funds is that they track the performance of the stock market or, specifically, the sector of the stock market represented by the index. This means that an investment in an index fund will never outperform the stock market. On the bright side, it will never underperform the stock market, either.
Index funds are considered reasonably conservative investments. Most mutual fund families have several index funds from which to choose, and their performance from fund family to fund family will be similar. Make your choices based on the management and transaction fees, which will cut into your return on investment and can be quite expensive.
- stocks and shares image by Andrew Brown from Fotolia.com