A mutual fund is a group of stocks, bonds, or cash combined in numerous
ways and sold as shares. When you invest in a mutual fund, your money
is combined with the money of others. For example: An Index 500 Fund holds
shares of stock from 500 of the largest U.S. companies (Microsoft, Exxon,
IBM, Walmart, etc...). It is designed to provide investors with a broad
exposure to the large capitalization sector of the U.S. Market. Each mutual
fund share contains a piece of each stock. If you own one share of a Index
500 Fund, you own a piece of all 500 companies.
Index funds come in all shapes and sizes: sector, large cap, small cap,
international, etc... Indexfunds.com lists
index funds in categories for you to view.
Another great reason to invest in index funds, low expenses. Many managed
funds which trade in and out of stocks frequently pay a fund manager to
research these stocks. Expenses and commissions can range from .18 percent
(many index funds) to over 6 percent (many commission based fund companies).
These percents do not look like much, but let us add the power of compounding:
*Index 500 Fund returns 13%, subtract .6% in expenses, total 12.4%. If
you invested $1000 right now at 12.4% and left it for 30 years, it would
be worth $33,340.
*XYZ managed fund returns 13% also, subtract 3% for expenses, total 10%.
If you invested $1000 right now at 10% and left it for 30 years, it would
be worth $17,450.
Absolutely amazing what a few percentage points can do over time! How
can Index Funds charge so little? They are considered "unmanaged"
funds. Yes, there is a fund manager and he or she monitors the stocks
and money flow. With most Index Funds, the fund manager invests half of
the total amount of money they are given equally among all the stocks
in the index. The manager then invests the other half in, what they feel,
are undervalued companies within the index, so not all index funds are
the same. Managers rarely sell shares of stock within the index and they
do not have to research stocks outside of the index, so fee's are low.