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7 Reasons Index Funds Are a Necessity in Your Investment Portfolio

Author: Maurie Backman | August 02, 2021

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What can index funds do for you?

When it comes to building an investment portfolio, you have choices. You could handpick stocks yourself, or you could fall back on index funds, which are passively managed funds that aim to match the performance of the different market indexes they're tied to. Here are a few reasons why it pays to load up on index funds.

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1. They don't require the same research as buying stocks

Buying individual stocks means having to spend time digging into different companies' financials and analyzing lots of numbers. It's a time-consuming process for sure. With index funds, you don't have to do all that legwork. You can simply compare funds based on the market index you want to invest in and see what their performance has looked like to date. You'll also need to compare fees, but that's an easy thing to do.

ALSO READ: 3 Index Funds Perfect for Achieving FIRE

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2. They lend to instant diversification

Having a diverse portfolio is important. It can protect you from losses when the stock market crashes, and it can help you grow more wealth over time. Index funds are diverse by nature. If you buy an S&P 500 index fund, for example, you'll basically get to own 500 different stocks. It's hard to get more diverse than that.

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3. They can give new investors more confidence

When you invest in index funds, you get to invest in the broad market. And that could help you approach the process of building a portfolio more confidently. Handpicking individual stocks puts a lot more pressure on you to make the right call.

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4. Their fees are low

Index funds have lower fees (called expense ratios) than their actively managed counterparts. That's because index funds don't have to pay fund managers to choose stocks -- they simply track indexes that already exist.

5 Winning Stocks Under $49
We hear it over and over from investors, “I wish I had bought Amazon or Netflix when they were first recommended by the Motley Fool. I’d be sitting on a gold mine!” And it’s true. And while Amazon and Netflix have had a good run, we think these 5 other stocks are screaming buys. And you can buy them now for less than $49 a share! Simply click here to learn how to get your copy of “5 Growth Stocks Under $49” for FREE for a limited time only.

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5. They can do just as well as actively managed mutual funds

It's often the case that index funds perform just as well as actively managed funds. Some even perform better. There are, of course, exceptions, and some actively managed funds are worth paying for, but don't assume you'll lose out on strong returns by choosing index funds.

ALSO READ: 3 Reasons You Shouldn't Be Afraid to Invest in Index Funds

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6. They can be less volatile

When you buy individual stocks, sometimes all it takes is for a company's earnings report to fall short or for a regulatory change to come down the pike, and boom -- that stock's value is down overnight. Because index funds are buckets of stocks, not single stocks, their value won't fluctuate as drastically when a single company takes a hit.

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7. They won't cause an undue tax burden

Anytime you sell stocks at a profit, you're required to pay capital gains taxes on it, assuming those stocks aren't being held in a tax-advantaged account like a 401(k) or IRA. But because index funds track existing market indexes, you don't tend to see much trading happening within each fund. And fewer trades generally means fewer taxes.

5 Winning Stocks Under $49
We hear it over and over from investors, “I wish I had bought Amazon or Netflix when they were first recommended by the Motley Fool. I’d be sitting on a gold mine!” And it’s true. And while Amazon and Netflix have had a good run, we think these 5 other stocks are screaming buys. And you can buy them now for less than $49 a share! Simply click here to learn how to get your copy of “5 Growth Stocks Under $49” for FREE for a limited time only.

Previous

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Are index funds right for you?

The one drawback of index funds is that they won't help you beat the market. If you want your portfolio to outperform the S&P 500, for example, then an S&P 500 index fund won't allow you to achieve that goal. But if you're OK with having your investment's performance match that of the broad market, then index funds are a really solid bet.

The Motley Fool has a disclosure policy.

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