Index Funds for Beginners: Passive Income
As you begin your journey investing in the stock market, index funds are a great way to earn passive income for beginners.
Index Funds pop up frequently as you start to navigate through investing in the stock market and it's important to understand how it works before investing in them.
As you may be indecisive about which stock to invest in, Index Funds allow you to invest in thousands of different companies all at once.
How does it work?
Index funds are like both ETFs and Mutual funds in that it contains a wide variety of investments under one fund, and it trades just like a stock. Instead of buying just one individual stock, you’ll be purchasing hundreds and thousands of companies at once through an index fund.
Index funds generate an income passively, as they aim to maximize returns by not buying and selling as often as mutual funds do.
The index usually contains the saving sector or asset classes, geography, or market capitalization where many other investors are investing into as well.
The Dow Jones and the S&P 500 are the most common index funds as they have almost every type of investment included.
The goal of these funds is to match a specific index such as all the investments that are included in the Dow Jones.
The index measures how well all aspects of the market are doing as a group. There are hundreds of market indexes to choose from that vary in all aspects of the economy.
You can purchase index funds through online brokers. Your online broker will then track the benchmark index for you letting you generate passive income.
Long-term Growth
Unlike active mutual funds where the aim is to generate market-beating performances, the index fund will give you a higher return in the long run.
“Over the past 90 years, the S&P 500 has earned an average return of nearly 10% per year,” according to Forbes. In the long term, index funds have better returns.
It’s hard with active mutual funds to determine the winning stocks and to time the market on a constant basis.
Fewer expenses
They are usually less expensive than mutual funds, even though both mutual funds and index funds keep a diversified portfolio.
Because the fund tracks how well the index does, it requires less effort and free trades than active mutual funds. There is no need for research analysts and additional services to pick the best stocks any longer with index funds.
With active mutual funds, there is more stock trading involved to exceed in the market requiring additional fees.
Diversification
With index funds the more companies that you include in your portfolio, the more you can diversify away from company-specific risk.
Therefore, exposing you only to broad market risk. “These risks include volatility, political events, changes in interest rates, and recessions, explains investingsimple.com.
One of the disadvantages of buying an index fund is the lack of control you have over your portfolio. Index funds are managed by index managers that control which companies should be included in the index.
Consider your overall investing goals before making a decision on choosing your index funds. There is a variety of different index funds to choose from. As a beginner investor, index funds are a great first investment as it carries less risk than individual stocks.
With your risk reduced, the chances for long term growth as you generate passive income is increased. With low fees and diversification, index funds are a smart investment.