Diversifying with index funds

You know that it’s important to spread your investments across stocks and funds of different sectors, regions, and sizes.

But you can also get broader and more strategic diversification at a low cost by investing in index funds.

What’s a market index?

A market index tracks the performance of a portion of the market.

There are over 5,000 market indexes in the world, tracking everything from clean energy to consumer staples, emerging economies, and commodities (like gold and oil).

Common market indexes

A few market indexes that are commonly used as a guide for the performance of the stock market overall include:

• Dow Jones Industrial Average: Tracks 30 large US companies
• Standard & Poor’s 500: Tracks the 500 largest US companies
• NASDAQ Composite: Tracks 3,000 investments listed on the NASDAQ exchange

How do I invest in a market index?

We can’t invest in market indexes directly, as they’re just a benchmark for performance. But we can invest in index funds.

What’s an index fund?

An index fund is a mutual fund or ETF that’s designed to try to match the performance of a market index.

For example, if the S&P 500 is the market index you want to match, there are many index funds you could invest in that try to mimic its performance.

Index fund benefits:

• More diversification than individual stocks
• Less overall risk than individual stocks
• Lower fees than actively managed funds

Index fund drawbacks:

• Less flexibility to what you’re investing in because investments in the fund are set to match the index
• Lower potential to outperform the market, as the goal of these funds is to match an index as closely as possible