Why Index Funds May Not Be for You

Index funds are a type of investment where a mutual fund attempts to track the movements of a particular financial index, such as the S&P 500. While this type of fund is great popular, it is definitely not for everyone. Here are a few reasons that you may not want to invest in index funds.

Costs

One of the drawbacks of investing in an index fund is the costs that are involved. In order to operate this type of fund, mutual funds have to charge you fees. These operating expenses are charged as a way to cover the costs that are involved with running the fund. They will pay for the salaries of the fund managers and the administrative costs. Since you are not making very large returns with this type of investment, you need all of the help that you can get to stay profitable. When they are taking one or two percent out of the returns, this can negatively affect your investment.

Down Markets

The basic idea behind an index fund is that it will track the movements of the stock market as a whole. These funds are very broad and include thousands of shares of many stocks. While this might be a good thing in some cases, during a down market, it can be devastating to your portfolio. When the market is down, the index fund will also go down. When you are trying to invest for retirement, you cannot afford to have the value of your portfolio decrease substantially within a short period of time. Instead, you might want to look for other types of investments that will not decline rapidly when the stock market declines as a whole.

Not Flexible

Another potential disadvantage of index funds is that they are very rigid. With this investing strategy, the fund managers follow a strict formula. When a company is added to the financial index, they will buy stock from the company. When a company is subtracted from the index, they will sell the stock. The stock market is a very dynamic place that requires constant attention. With this type of investment, you cannot adjust the investment strategy to suit the market. You have to stay with the same strategy regardless of how to is performing. With other investment strategies, you can look for other types of investments when something is not working.

Liquidity

Another issue with index funds is that they have issues with liquidity. If you want to buy or sell shares of an index fund, you have to put in your order during the trading day. At the end of the trading day, they will calculate the net asset value of the fund and will process all the orders. This means that you can only make transactions at the end of the day and you do not know the price of your purchase or sale.

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