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Index Funds: Diversification at a Low Price

By Motley Fool Staff – Oct 12, 2016 at 9:27PM

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When it comes to diversification, it’s hard to beat an index fund.

Index funds have a few advantages, particularly as it relates to low-cost diversification. Some index funds enable investors to buy practically all stocks listed on markets in the United States, with portfolios that include 3,400 companies.

In this segment of Industry Focus: Financials, The Motley Fool's Gaby Lapera and Jordan Wathen discuss the diversification advantages of index funds vs. actively managed mutual funds.

A full transcript follows the video.

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This podcast was recorded on Sept. 14, 2016.

Gaby Lapera: The other thing that's really good about index funds is diversification.

Jordan Wathen: Right. Diversification, after costs and being a passive investor, it's one of the biggest benefits. To use an example, there's an index out there and it's very popular. It's called the Total Stock Market Index. It basically tracks every single stock in the United States that's a practical size to actually own. Vanguard's Total Stock Market Index for the United States holds more than 3,600 stocks, which is extreme diversification. The only stocks it voids are stocks with market caps, or market values, of less than $10 million, which are really just stocks that are too small for the fund to even hold, or buy and sell out of. To put that in perspective, there's this website out there where you can basically buy and sell private companies, and I've seen car wash chains sell for more than $10 million. At that valuation, you're not missing out on much. It's basically the stock market, the whole thing -- 99.9% of it.

Lapera: Yeah. But if you want to get a little bit more specific than that, you can be, like, "I want to invest in a consumer goods index fund, and it's an index fund that tracks consumer goods companies."

Wathen: Yeah. There's a new ETF that came out recently. It's technically an index fund because it tracks an index, and it trades under the ticker symbol SLIM. It actually tried to invest in companies that would make money on the growing obesity problem. So, these can get extremely specific.

Lapera: That's crazy. That's a very clever ticker symbol. I always get a chuckle out of some of them. That's really smart, I'll have to look into it. Basically, diversification is the opposite of having all your eggs in one hand basket. You basically have one hand basket for every egg you've ever bought in your entire life, which keeps them all gently padded and safe.

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