Indexed Investment Portfolio
What Is Indexing?
Indexing is an investment approach that seeks to match the investment returns of a specified stock or bond market benchmark, or index. Indexing, attempts to replicate the investment results of the target index by holding all-or in the case of very large indexes, a representative sample-of the securities in the index. There is no attempt to use traditional “active” money management or to make “bets” on individual stocks or narrow industry sectors in an attempt to outpace the index. Thus, indexing is a “passive” investment approach emphasizing broad diversification and low portfolio trading activity.
Low Management Cost – Index funds typically have lower management costs. This is because it costs less to operate an index fund as there is less need to employ highly paid research and investment analyst teams.
Low Transaction Cost – Index managers use a ‘buy and hold’ approach which means that they typically have lower turnover levels than active fund managers resulting in lower transaction costs and taxes. Transaction costs can include brokerage, commissions, stamp duty, custody and other expenses associated with trading securities.
Lower Taxes – Tax can potentially take the largest chunk out of your investment return so it pays to focus on your real return, after tax. The way in which an index fund is managed with minimal turnover of the underlying assets means that indexing offers tax benefits by potentially reducing investor’s capital gains tax liability.
Diversification – Index funds invest in all or a representative sample of the securities in an index. So when you invest in an index fund you are effectively buying the entire market, or a representative sample of it. It reduces your risk by leaving you less exposed to the performance fluctuations of single investments, and fund managers for that matter.
Simplicity – Indexing simplifies the investment process. It is very difficult to continually pick winners and outperform the market over the long term – even the professionals can get it wrong. Instead of trying to guess which fund managers will outperform the market in the future, an index fund provides a low cost way to closely track market returns.