Index funds are created to mirror the investment results of a specific market index. It can consist of either stocks or bonds in its portfolio, and these mutual funds differ in the strategies that they use to achieve returns parallel to their chosen index. Index funds oppose with non-index funds, which seek to improve on market returns instead of aligning with them.
There are advantages and disadvantages of using stock indexes and the index funds that trace them. An index fund is an imagined portfolio of securities signifying a specific portion of the wider market. It is typically made using the shares of leading companies in the economy or in a particular area of the economy. Today, this article will be tackling some of the disadvantages of index fund investing to help you widen your knowledge about this type of investing.
- Absence of Drawback Protection
The stock market has ascertained to be a great investment in the long run, but over the years, it has had its fair share of ups and downs. Investing in an index fund, such as one that traces the S&P 500, will give you the advantage when the market is performing well, but also makes you totally exposed to the drawbacks. You can decide to limit your exposure to the index through shorting the index, or buying a put, an option contract providing right to the owner to sell a specified amount of an underlying asset at a set price within a specified time, against the index.
- No Huge Gains
An index fund doesn’t have the ability to outdo the market the way managed funds do. This means that if you invest in an index fund you are disregarding the possibility of a huge gain. The top-performing non-index funds in a given year work better than an index fund in a year. However, the top-performing non-index funds may differ from year to year, so that under-performing years can stop the over-performing ones, while index fund’s performance remains more stable.
- No Control Over Holdings
Indexes are set portfolios. If an investor purchase an index fund, he or she has no control over every holding in the portfolio. You may have certain companies that you want to own, such as a favorite bank or food company that you have found on the net and want to purchase. Likewise, in daily life, you may have events in your life that lead you to believe that one company is notably better than the other, maybe it has the best brands, management or customer service. As a result, you may want to invest particularly in that company and not in its rivals.
- Reduced Personal Satisfaction
Investing can be distressing and nerve-wracking, especially during times of disorder. Choosing a certain stock may leave you constantly looking after quoted price, and can keep you awake at night, but these situations will not be prevented by investing in an index. You can still find yourself constantly checking on how the market is performing and being worried sick about the economic landscape. Above all these, you will lose the satisfaction and excitement of creating good investments and being profitable with your journey.