EXPLAINER: The Pros and Cons of Investing in Index Funds

This simple diversification that index funds allow will make it close to impossible for you to suffer any big losses in case a company faces any bad situations.

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Index funds are investment funds that are built to track the performance of a market index. They include a number of investments and they tend to be diversified in securities across that index.

Index funds track the movement of sectors and markets on a daily basis in order to gauge the market’s health and performance. If the predictions are right, you will get money from index funds.

So what are the pros of investing in index funds?

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SEE ALSO: EXPLAINER: A Look at Money Market Funds as an Option for the Risk-Averse Short-Term Investor in Kenya

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Here are some of the benefits of index funds:

  • Lower risk through diversification
  • Low expense ratios
  • Strong long-term returns
  • Ideal for passive, buy-and-hold investors
  • Lower taxes for investors

Since you can include hundreds of stocks and other investments in index funds, you are more likely to invest with less risk.

This simple diversification that index funds allow will make it close to impossible for you to suffer any big losses in case a company faces any bad situations.

Index funds are one of the last expensive investment options unlike other actively managed funds. With index funds, you do not need a team of research analysts for research or a fund manager to select the stocks. An index fund manager only buys the stocks and they do not need to put their expertise in their portfolio.

On the other hand, index funds have a few cons as well:

  • Vulnerable to market swings and crashes
  • Lack of flexibility
  • No human element
  • Limited gains

With index funds, you do not get to pick and choose what stocks you want to buy and those that you do not want to buy. For any investor, this is not good because you will end up having stocks you do not want or even miss out on other stocks because of the index you have chosen. 

The thing about investing in index funds is that you will not get any big financial gains in the early stages of the investment journey.  

You have to be fully invested in the index funds and pick the right indexes if at all you want to start getting any returns.

If you are persistent and consistent, you will start making the big financial gains in the long run.

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RECOMMENDED READING: 3 Must Know USSD Codes for Investors in Kenya

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