Index funds
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| Portfolio Design |
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Introduction
An index fund[1] is a mutual fund that seeks to replicate the movements of an index of a specific financial market (e.g. S&P/TSX 60, S&P 500, etc.). This is accomplished by:
- Holding all of the stocks or securities in the index, in the same proportions as the index, or
- Holding an optimized subset of the stocks or securities in the index, maintaining a very high correlation between the index itself and the subset.
Most indexes are market value weighted.[2] This approach may overweight over valued stocks and underweight under valued stocks. Fundamental weighting[3] is relatively new and provides weighting by a combination of fundamental factors such as sales, book value, dividends[4], and earnings. Although thoroughly back tested over many countries and time periods, it remains to be seen whether actual results going forward will mirror test results. These alternative weightings are sometimes considered to be a type of value investing.[5]
Since the composition of an index fund is a known quantity, they generally have lower management expense ratios (MERs) than actively managed mutual funds[6].
Index ETFs
Many index funds are available in the form of ETFs. These ETFs frequently have a lower expense ratio than do similar mutual funds.
Comparison of Mutual Funds and ETFs
Mutual funds and ETFs are compared in the following table:
Comparison of Mutual Funds and ETFs Mutual Fund ETF Readily available Requires a brokerage account No-load funds available Has purchase and sales fees and bid-ask spreads MER usually >0.5% MER often <0.5% End-of-day pricing of trades Immediate pricing of trades
Because of these differences, mutual funds are more suitable for small, frequent purchases. ETFs are frequently cheaper for one-time major purchases.
References
- ↑ Wikipedia, Index fund, viewed Feb. 21, 2009.
- ↑ Wikipedia, Capitalization-weighted indexes, viewed Feb. 25, 2009.
- ↑ Wikipedia, Fundamentally based indexes, viewed Feb. 25, 2009.
- ↑ Dow Jones, Dow Jones Select Dividend Indexes Methodology Overview, viewed Feb. 25, 2009.
- ↑ Wikipedia, Fundamentally based indexes, op. cit.
- ↑ "Bylo Selhi", Low-MER, No-Load Index Funds Available in Canada, viewed Feb. 21, 2009.
