What are Index Funds?
Index funds are passively managed investment funds that track a stock market index. The management only buys the shares that are in the respective reference index such as the S&P500, which contains the largest 500 market capital companies in the US.
You might be asking yourself, but what is an index? An index is simply something that indicates. In this case, a stock market index is a collection of stocks that indicates how the market is performing, and an index fund mimics it.
There are roughly 400 different stock market indices which can find a list here, but only a few of these are a popular choice with investors. The top 7 most popular stock market indexes are:
- Dow Jones Industrial Average (DJIA)
- Standard and Poor’s 500 (S&P500)
- Russell 3000 Index
- Financial Times Stock Exchange 100 Index (FTSE 100)
- Nikkei Stock Average (Nikkei 225)
- Hang Seng Index (HSI)
- Nasdaq 100 (NDX)
Where can you invest in an Index Fund?
200 AED Only
And access:
• Social Trading
• Copy Portfolios
• Over 2000 Markets
Index Funds With The Highest Historical Returns
| Index Fund | 1 Year Return | 5 Year Return |
| China A50 | 30.14% | 87.16% |
| JPN225 (Nekkei 225) | 27.25% | 83.23% |
| NSDQ100 | 39.84% | 203.96% |
| UK100 | 10.64% | 13.49% |
| SPX500 (S&P500) | 34.45% | 99.71% |
| HKG50 | 17.10% | 36.07% |
| GER30 | 34.80% | 53.04% |
| AUS200 | 21.32% | 37.02% |
| EUSTX50 | 24.51% | 36.10% |
Advantages of Index Funds
A major advantage of these index funds, which are usually offered as ETFs (exchange traded funds), is their low cost. Since management replicates the composition of an index, and therefore only has to rebalance in the event of changes within the reference index, there is little expense.
- Lower costs because its simpler to manage
- Diversified investment that replicated the market
- Relatively low risk when compared with owning single stocks
- Ideal for passive investors or newcomers
- Transparency in what you’re investing in
- Consistent returns across long periods of time
Disadvantages of Index Funds
What is considered to be an advantage can also sometimes be considered as a disadvantage. While portfolio diversification is often a looked after term, in the word of investing it’s often preferred to own 1000 AED’s worth in 1 great company, than 1000 AED’s worth in 10 good companies.
Diversifications isn’t the only downside. Since these often cover the largest markets, you’ll most find index funds of the world’s most popular markets, but to markets such as the UAE. For that level of targeting, you’ll need to resort to ETFs.
- Lack of control in the companies you invest in
- Limited in choice
- Typically requires a minimum investment of at least AED 2000
Index Fund Managers
Since an index fund is a collection of stocks, fund managers also need to agree on the distribution of stock ownership, known as weight. Imagine you’re creating a new index fund and you have AED 100 you need to allocate to 5 different stocks. You can decide to split your investment equally across all 5 at 20% weight, or you can invest 40% in the 1st, 20% in the 2nd, and the remaining split equally between 3rd, 4th and 5th. Both options are great, but it’s up to fund managers to take the decision on which approach to take based on the strategy.
Index fund managers also weight the shares exactly as in the stock market index. If, for example, a share is included in the index calculation with a weighting of 5%, the fund also has 5% of these shares in its portfolio. This distinguishes index funds from actively managed funds, where the management implements its own investment strategy.
Index Funds vs ETFs
It’s understandable to get confused between an index fund and an ETFs, especially since brokers nowadays offer index funds in the form of ETFs. The main difference behind an ETF and index fund is the way they are structured. Both of them contain a collection of companies, but ETFs might also contain commodities, bonds, crypto, or other assets.
Index funds are fueled by a simple underlying rule, own a piece of X amount of companies with the largest market cap in country ABC. It’s universal, understandable, and not questionable. ETFs on the hand are owned by the exchange offering the ETF, so the rule of what’s included in that particular ETF is dictated solely by the exchange. This difference has it’s advantages and disadvantages but if you’d like to learn more about ETFs we strongly recommend you checking out our ETF trading platforms page.
When it comes to fees, ETFs and index funds hardly differ. For example, the annual management fees (total expense ratio, TER) average 0.39% for ETFs across various asset classes and 0.43% for index funds, so it’s negligible.
When both ETFs and index funds are available on a particular broker, you need to decide on a situational basis which product type is more suitable. You should take into account criteria such as the investment strategy, risk aversion and the intended holding period. Normally, it makes sense to use both ETFs and index funds in your portfolio.
