An index is a tracker that is used to measure the performance of a group of stocks by taking the average of stock price movement per stock. For example, the S&P500 is an average of the top 500 companies. This index tracks the performance of the top 500 companies. It can be useful to look at indexes to study the overall move of the market. For example, if the S&P 500 is down then we can assume the most of the 500 companies are down as well.
Index Fund or Index Stock Explained
An index fund, also known as index stock, is an asset that you can purchase and is managed by a company. Their goal is to make sure the index fund matches the performance of the index as much as possible. The index fund will be actively managed by professionals to keep the good proportion of each stock in its portfolio. For example, the company Vanguard has multiple index funds and one of them is Vanguard S&P 500 ETF that goes by the ticker symbol VOO. These index funds are actively managed to track down the S&P 500, they will buy and sell shares of all the 500 companies in the S&P 500 to match as much as possible the S&P500 index. There is a fee if you own the VOO index fund which is 0.03%. Most index funds have varying fees, depending on the fund and the company managing it.
Why are index stocks safer than buying regular stocks?
They are safer for the simple reason that they follow the average performance of the market. Statistically speaking, the average performance of the market every year is around 10%. Therefore, just by investing in an index fund, you know that your return, statistically speaking, is a 10% average per year. Some years can be less while others can be more than 10%.
Another reason is by investing in an index fund, you ‘own’ a small portion of multiple companies. If ever one of the companies goes bankrupt, it will not affect your portfolio much. In the case you made your own portfolio and only invested in three different stocks and one of them goes bankrupt, it will tremendously affect your portfolio.
What are Actively Managed ETFs?
Actively managed ETFs are just like index funds managed by a company, but the difference is they do not track an index. They can be any ETFs of the company’s choice. For example, Ark Invest’s Next Generation Internet ETF (ticker symbol ARKW) holds 48 companies and the top 4 companies in those ETFs with the highest weights are Tesla, Shopify, Twitter and Square.
Active ETFs also have a fee just like index funds. The reason why someone would invest in an active ETF is that it is more precise to a sector and have fewer company compared to S&P500. In other words, what if I want to own the top technology company from the S&P500 only, that when an active ETF can come in handy.
There are multiple Active ETFs made by numerous companies, our personal favorites are Ark Invest’s Active ETFs. They have multiple options and most of them outperform the S&P500. These are some of their Active ETFs.
You can search into each and look at their holdings and see what you prefer. This can be done with any actively managed ETFs. Ark Invest’s ETFs are just an example, there are many more.
Should I invest in Index Funds and/or Actively Managed ETFs?
Index funds and actively managed ETFs are more for a long term portfolio, and it is much more of a safer investment style. You know that in the long term there is very little risk, and you will have an average return of 10% for an index fund and for actively managed ETFs depending on the chosen ETFs.
Another element is that the company that manages these funds takes care of the buying and selling process. You, as an investor just have to keep buying the same fund over and over if you wish to add into your position over time.
We recommend index funds and actively managed ETFs for a long term portfolio, a portfolio that you intend on only investing in and without selling for the next 5 to 10 years. They can represent a good percentage of your long term portfolio. You can add other companies of your choice that you believe will do great in the long term. This way, your portfolio can have some risk as well for greater gain while still holding a majority in index or actively managed ETFs.