Image by: Financial Times
Index funds are one of the most effective tools for creating long-term wealth.
At the click of a button, you can own thousands of the biggest and most profitable businesses in the world.
Even Warren Buffett recommends that most investors should invest in passive index funds.
But can you own too many index funds?
Moreover, should you invest the minimum investment amount in multiple index funds at once?
In this article, we’ll help explain index funds, their pros and cons, and determine whether it makes sense to own multiple index funds.
Prepare to level up your investment game with this comprehensive index fund guide.
In this post:
What is an Index Fund?
An index fund is a type of mutual fund or exchange-traded fund (ETF) that aims to mimic a specific market index.
A market index is a basket of stocks or other assets that tracks the overall performance of a particular segment of the market.
Some of the most popular stock indices not are…
- S&P 500 (Standard & Poor’s 500): The S&P 500 is one of the most well-known stock indices in the United States. It includes the 500 largest publicly traded companies in the U.S. and represents about 80% of the total U.S. stock market capitalization.
- NASDAQ Composite: The NASDAQ Composite index represents all the companies listed on the NASDAQ stock exchange. It is known for its heavy representation of technology companies, including many major tech giants like Apple, Microsoft, Amazon, and Google (Alphabet).
- Dow Jones Industrial Average (DJIA): The DJIA is one of the oldest and most widely recognized stock indices globally. It consists of 30 large, publicly traded companies in the U.S., selected to represent various sectors of the economy.
- Hang Seng Index: The Hang Seng Index represents the 50 largest companies listed on the Hong Kong Stock Exchange and is widely followed as a benchmark for the Hong Kong stock market.
- FTSE 100: The Financial Times Stock Exchange 100 Index represents the 100 largest companies listed on the London Stock Exchange (LSE) in the United Kingdom.
A few of the most well-known stock index funds and exchange-traded funds (ETFs) that match these indexes are listed:
S&P 500 Index Fund:
NASDAQ Composite Index Fund:
Dow Jones Industrial Average (DJIA) Index Fund:
Hang Seng Index Fund:
- Tracker Fund of Hong Kong (2800)
FTSE 100 Index Fund:
The main objective of fund managers is to closely match the returns of the underlying index it tracks.
To do so, the fund’s diversified portfolio is built to hold the same weight of each asset within the index.
For example, here is the weighting of the largest stocks within the Vanguard S&P 500 ETF…
Image By: Vanguard
As you can see, Apple makes up roughly 7.67% of the fund, while Microsoft, Amazon, NVIDIA, and Alphabet make up 6.77%, 3.11%, 2.80%, and 1.90%, respectively.
This compares to the actual S&P 500 index, where Apple, Microsoft, Amazon, NVIDIA, and Alphabet make up 7.51%, 6.45%, 3,06%, 2.92%, and 2.03%, respectively.
Essentially, when you purchase an index fund like S&P 500, you receive ownership of all the stocks within the fund at their respective weighting.
So, owning an index fund gives you ownership of some of the largest and most well-respected businesses in the world, all at a fraction of the cost.
How Much Do Index Funds Cost?
When it comes to index funds, the costs can vary depending on a few important factors, such as the fund provider, the type of index it tracks, and the specific index fund provider’s management expenses.
That being said, one of the fantastic advantages of index funds is their cost-effectiveness and lower expense ratios compared to an actively managed fund.
The expense ratio represents the annual fee charged by the fund to cover its operating expenses, typically expressed as a percentage of the fund’s expense ratio to total assets under management.
On average, you can find index funds with expense ratios ranging from as low as 0.05% to around 0.40% or slightly more.
It’s always good to be aware that expense ratios might change over time, so make sure to double-check the current ratio of any specific index fund you’re interested in.
You can do this by reaching out to the fund provider directly or by reviewing the latest prospectus and reports.
Image By: Investopedia
While you are at it, keep an eye out for other associated fees like transaction fees, redemption fees, or account maintenance fees, as they can impact your overall investment returns.
The bottom line is, we want to ensure you pick one or two low-cost index funds that align perfectly with your investment goals while keeping those costs in check.
After all, you deserve an investment strategy that’s both fruitful and friendly to your wallet!
Lucky for you, index funds are among the most affordable options out there, especially when compared to actively managed funds like mutual funds or hedge funds, where an investment manager takes the reins.
How to Choose an Index Fund
When choosing an index fund, you will want to consider several factors before making your decision.
Here are a few important steps to help you select the best index fund for your investment needs:
Step 1: Define Your Investment Objectives
Take a moment to outline your investment objectives and financial goals. Consider factors like your time horizon, risk tolerance, and what you aim to achieve (retirement, wealth building, education funds).
This will help us pinpoint the ideal index funds that align perfectly with your needs and ensure your investment journey is predictably rewarding.
Step 2: Select the Index
Moving on! Identify the market or sector you want exposure to and assess the composition of various funds.
There’s a wide range of indexes available, from the S&P 500 to the Nasdaq Composite and Russell 2000.
Choose the index that best fits your goals, and don’t hesitate to consider multiple indexes if needed.
Step 3: Compare Expense Ratios
Don’t forget to compare the expense ratios of different funds tracking the same index.
Lower expense ratios mean more money in your pocket, so let’s keep an eye on those.
Step 4: Consider Fund Size and Assets Under Management (AUM)
Size matters! Evaluate the fund’s size and AUM to gauge its popularity and efficiency in tracking the index.
Bigger funds often offer lower expense ratios due to economies of scale, but let’s also keep in mind that overly massive funds might lack flexibility in stock selection.
Step 5: Evaluate Performance
While index funds aim to mirror specific indexes, slight variations can occur due to tracking errors.
We’ll analyze the historical performance to ensure consistency, though remember that past performance is not a guarantee for the future.
Step 6: Check the Fund Structure
Mutual funds or ETFs? You decide! Both have their perks, like liquidity, ease of trading, and tax efficiency.
Let’s go with the fund structure and index fund provider that suits your preferences best.
Step 7: Assess Diversification
Spreading risk like a pro! Ensure that the index fund provides adequate diversification within its holdings.
A well-diversified fund helps spread risk and reduces exposure to any single company or sector.
Since you are not actively investing in individual stocks, it is valuable to own a fund that does not adopt unnecessary risk, unless it provides you with an adequate return.
Step 8: Review Fund Holdings
Similarly, take a look at the fund’s holdings to see if it accurately reflects the composition of the target index.
If you aim to own a select few stocks, then find the fund that similarly possesses those stocks to how you would want to invest in them on your own.
Step 9: Check Fund Manager and Company Reputation
Research the fund provider and the fund manager’s track record.
It is worthwhile choosing a reputable and established fund company with a history of managing index funds effectively.
The last thing you want is to be shocked when a fund collapses out of nowhere due to poor management.
Step 10: Read the Fund Prospectus
It is important to understand any asset that you plan to invest in.
Always thoroughly review the fund’s prospectus and relevant documents, giving you a comprehensive view of what the fund offers and making sure you’re fully informed.
Is Investing in Multiple Index Funds Risky?
Image By: Financial Times
Investing in multiple index funds can be a great way to build exposure and diversification in multiple emerging markets, and economies at once.
Generally, it is considered less risky than putting all of your money into a single investment or asset class, but this also comes at some cost.
If you plan to invest in multiple index funds, here are a few of the benefits and risks of investing in index funds and pursuing such a strategy:
Pros of Investing in Multiple Index Funds:
Pro 1: Diversification
Investing in multiple index funds means spreading your holdings across various industries, regions, or asset classes.
This diversification helps to reduce the impact of negative performance in any single fund, keeping the overall volatility of your portfolio in check.
Pro 2: Lower Individual Risk
By holding multiple funds, you’re not putting all your eggs in one basket.
This reduces the risk associated with the short-term volatility of any particular fund.
You can rest assured that your investment isn’t solely reliant on the performance of a single fund.
Pro 3: Capture Different Opportunities
Market conditions can vary, and different indexes may shine in different scenarios.
By investing in multiple funds, you allow yourself to capture potential growth in various areas of the market.
Pro 4: Flexibility and Customization
Investing in multiple index funds allows you to tailor your portfolio precisely to your investment goals and risk tolerance.
You’re in control and can adjust your allocation based on changing market conditions or your long-term objectives.
Pro 5: Cost-Effectiveness
Many index funds come with low expense ratios, making it cost-effective to diversify your investments across multiple funds.
This means you can spread your money without worrying about hefty fees eating into your returns.
Risks of Investing in Multiple Index Funds
Risk 1: Asset Allocation
It’s essential to determine the right asset allocation based on your goals and risk tolerance.
Allocate your investments across different asset classes (like equities, bonds, and real estate) and then choose index funds within each class to maintain a well-balanced approach.
If you are someone seeking proper diversification, be wary of those that over-allocate into one sector or another.
Risk 2: Overlap and Correlation
Keep an eye out for potential overlap and correlation between different index funds.
Some funds may have similar holdings or buy index funds, which can reduce diversification. Do your research to ensure you achieve the level of diversification you’re aiming for.
Is Now a Good Time to Invest in Index Funds?
Image By: Columbia Threadneedle Investments
Timing financial markets is a challenging feat, even for the best investors.
While there may be better periods where the market conditions are ideal for investment, it is difficult to tell when a market or asset will turn around exactly.
As the saying goes, “Time in the market beats timing the market.”
Therefore, rather than trying to figure out where the market is at or if it is a good time to invest in index funds, focus on making consistent investments and pursuing your long-term financial goals.
Over time, it is more than likely that your investments compound at an effective rate of return, providing you with the adequate wealth you so deserve.
However, if you sit on the sidelines waiting for the perfect investment opportunity to come, you may never get that chance, and you’ll miss out on meaningful gains you otherwise would have made.
The easiest and most sure-fire approach to building wealth is through a simple dollar-cost-averaging strategy.
Dollar-cost averaging (DCA) is an effective investment strategy in which an investor regularly invests a fixed amount of money into a particular investment, regardless of the asset’s current price or market conditions.
The investor buys more units or shares when the price is lower and fewer units or shares when the price is higher.
While you may own less when you purchase near the peak, it will mean very little over the lifetime of your investment journey.
In other words, why waste more time and effort than you need to when the goal is to create long-term wealth for you and your family?
Final Thoughts: Should I Invest in Multiple Index Funds?
Investing in multiple index funds is one of the easiest and most effective ways to create long-term wealth.
Many investors are drawn to this approach because of the passive and low-cost nature of index investing.
It can also help you build exposure in multiple markets at once, without the hassle of analyzing individual stocks.
However, it might not be the ideal strategy for you if you are attempting to generate market-beating returns given that index funds produce average results as opposed to better or worse.
Regardless, it ultimately comes down to your investment objectives and personal preferences.
If your goal is to invest money and compound your wealth with ease, then this is a great option for your investment account.
Stick to the course and watch as your money grows before your eyes, making you wealthier than ever before.
Disclosure/Disclaimer:
We are not brokers, investment, or financial advisers; you should not rely on the information herein as investment advice. If you are seeking personalized investment advice, please contact a qualified and registered broker, investment adviser, or financial adviser. You should not make any investment decisions based on our communications. Our stock profiles are intended to highlight certain companies for YOUR further investigation; they are NOT recommendations. The securities issued by the companies we profile should be considered high risk and, if you do invest, you may lose your entire investment. Edge Investments and its owners currently hold shares in CopAur Minerals and have been compensated for content creation, amounting to twelve thousand dollars. Edge Investments and its owners reserve the right to buy and sell shares in CopAur without further notice, which may impact the share price. Please do your own research before investing, including reading the companies’ public filings, press releases, and risk disclosures. The company provided information in this profile, extracted from public filings, company websites, and other publicly available sources. We believe the sources and information are accurate and reliable but we cannot guarantee it. The commentary and opinions in this article are our own, so please do your own research.
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Declan O’Flaherty Declan holds a Bachelor of Commerce from the University of Alberta and has over 4 years of experience investing in financial markets.As a fundamental investor, Declan embraces the investment principles of Warren Buffett and his disciples. This puts a focus on finding businesses with healthy financials, competent and accountable leader, enduring competitive advantages, and those that are selling at discount to what they are worth. View all posts
