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How Index Funds Work

An index is what’s used as a baseline for measuring something. In the stock and investing world different indexes made up of investments are used to measure the performance of different areas of the market. Today’s video I’ll help you understand what an index is and how index funds work so you can use them […]

An index is what’s used as a baseline for measuring something. In the stock and investing world different indexes made up of investments are used to measure the performance of different areas of the market.

Today’s video I’ll help you understand what an index is and how index funds work so you can use them in a smart way when you invest. Let me know in the comments below if you’re already investing, or hoping to invest soon!

According to the numbers, most people (including professional money managers)  don’t perform better with their stock portfolio than the index, so why are people still trying and what should you do?

There’s a saying that concentration builds wealth and diversification maintains wealth. With this thought, it would make sense if you are in the wealth-building part of your life to be concentrated with your investments…

The problem is, CHOOSING the individual stocks out of every stock available that will do really well and better than the market as a whole.

An index fund is a way to invest in a bunch of stocks all inside one investment.

Indexes in the investment world are a group of stocks that meet certain criteria, like being a small, medium, or large company. The major indexes are the S&P 500 which is 500 of America’s largest companies, the Dow which is 30 American companies that used to be industrial stocks, but now there isn’t a set rule for stocks to be included in this index, they are major US companies that are very well known and relevant in most peoples lives. The Nasdaq is technology stocks and the Russel is comprised of small companies.

It would be pretty expensive, difficult, time-consuming, and impossible to keep track of all of your stocks if you wanted to buy everything in one or all of these indexes.

Luckily we don’t have to go and buy the stocks individually because there are money managers who have put all the stock together in different index funds that hold the same stocks as the index that they represent.

For example, if you bought an S&P 500 index fund, you would only see one investment in your account, but you would be the owner of all the stocks within the index. That means you would own the majority of companies you know and use every day like Apple, Facebook, Amazon, Coke, Google,  etc. 

The money manager that put the fund together isn’t actively managing the investments within the fund. They figuratively wrap a bow around what’s assigned to the index and offer it to us at a really low cost since they aren’t doing any work to manage the fund the way a typical mutual fund is managed.

People are turning to index funds way more now because of the low-cost way to get invested. In addition to the fees being really low or even free at some places like fidelity who offers a few zero-fee index fund options, they also statically perform better than the average investor who is buying and selling on their own and even better than professional money managers that actively manage and hand-select the investments within their funds.

As you saw, it really doesn’t make sense to pay more and get worse performance, so keep that in mind when you are deciding what to invest in.

Most people really want a way to get the most return in the quickest way and that is part of why they may choose to go to investing riskier in things like cryptocurrency, cannabis stocks, or other penny stocks. People try and outsmart the market in a sense, but most of the time those people just lose money. You can see it here when we look at the average account performance of a Robinhood investor compared to the S&P 500.

So when it comes to using index funds in a smart way, you don’t need to get a ton of different funds, because each fund already has so many stocks in it, from 30 to over 3,000, so if you also get a ton of different funds you could just be over diversifying. When deciding what to get, you can choose one fund for each area of the market, like one for small, medium, and large companies, one international, and one from the bond market. Simplify to magnify. 

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