By Pat McKeough, TSINetwork.ca
Special to the Financial Independence Hub
Index mutual funds can provide a low-cost way to invest in the stock market. However, they have disadvantages and there are better alternatives.
Index mutual funds are among the better financial innovations to come along in the past few decades. These are specialized mutual funds that invest so as to come close to equaling the performance of a market index, such as the S&P/TSX 60.
Index mutual funds do show better long-run performance than more than half of all actively managed mutual funds with long-term track records. That’s partly because index fund fees run around 1.0% of assets per year, compared to 2.5% or more on many broker-sold mutual funds.
One big advantage of index mutual funds is that they can help you avoid the risk of choosing a fund with a management style that virtually guarantees below-average long-term performance.
For example, mutual funds that pursue a trading or sector-rotation approach to investing belong in this can’t-win category. Managers of these funds try to out-perform the market by betting on relatively short-term trends, rather than putting their investors in a position to profit near automatically from long-term growth in the economy. This can work, but only for limited periods.
In any one year, the top fund is often run by a market timer who is having his or her proverbial “day in the sun.” In any one decade, however, the top funds are generally run by conservative managers who focus on long-term growth in the economy.
Spread investments across five main economic sectors