How to Recognize a Great Index Fund?

Before beginning to describe the indicators that help one narrow down to a great index fund, it is well worth taking a look at what exactly makes up such a fund. Simply put, an index fund has a portfolio designed to match or trace the components of a market index. Richard Cayne Meyer mentions a few examples of market indexes to include the Standard & Poor’s 500, the Russell 2000, DJ Wilshire 5000 and the MSCI EAFE (stocks in Europe, Australia and Far East).

Index fund investing is generally categorized as passive investing, since it requires very little research and knowledge on the part of the investor and still offers decent returns. Richard Cayne Meyer explains that the index fund was created to get rid of most of the variables that are almost impossible to overcome. Since an index fund buys all the assets on the given index such a fund primarily eliminates the risks entailed by manager selection, individual stocks and market sectors, leaving behind only stock market risks to deal with. However, Richard Cayne Meyer advises that this does not exempt index funds from all their variables and thus, the following guidelines should be observed in order to pick the highest quality funds for your portfolio.

Richard Cayne Meyer advises that index funds are essentially low-fee instruments, which means they are a great way of minimizing the expenses on your portfolio. However, he also goes ahead to warn that choosing to go with a particular index fund only because it entails a low fee is not the best strategy either. This is why it becomes necessary to take the following factors into account as well.

Whenever evaluating an index fund it only makes sense to correlate it to the market. For instance, if the S&P 500 went up 1.5% in the past six months and your S&P index fund only went up 1%, it might very well be eroding due to high fees. However, Richard Cayne Meyer suggests though there can never be a 100% correlation, one must study the results over a longer period of tim e. Richard Cayne Meyer further advises that one should avoid investing only in single asset or sector funds, such as funds that revolve around the index of only one country.

Last, but not the least, Richard Cayne Meyer advises that it is important to understand the index your fund will be following. For instance, the S&P 500 is an index that is based on 500 different stocks that represent a cross-section of the economy. With a plethora of indexes, and hence index funds out there, it makes sense to do a little analysis before making a final decision.