Once you’ve made up your mind to make forays into the investment world, you must brace yourself for a bumpy ride, no doubt. The fact that, more often than not, the risk involved is directly proportional to the possible return on investment. The more risk you are willing to take, the higher the returns.
But that’s the language of business after all. If you want a safer investment, have in mind that the returns are likely to be low and slow.
If you are considering investing in the stock market, you’d have to equip yourself with some fundamental knowledge about how the stock market index works. Doing so will put you on a trajectory to outstanding results, provided every one of your steps is adequately calculated and made with great caution.
Before we dive deeper into why and how you can invest in the stock market, however, let’s first define the stock index, also known as the stock market index.
What Is A Stock Index?
The term stock index might sound familiar to you if you’ve read about investing in stocks. In layman terms, a stock index is an index that measures or indicates the stock market. It helps investors tell the market’s performance of a particular security based on its history and current state.
Few people tend to think that the stock index and stock exchange are the same things. That’s not true as a stock exchange is where you buy or sell stocks or other securities, whereas a stock index is a measure of security.
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Why Invest in Stock Indices?
Most investors have no idea that it’s relatively easy to invest in a stock index and that it’s an effective way to build wealth compared to investing in a managed fund.
There are numerous studies that support John Bogle’s theory of investing in index funds rather than chasing the promised high returns with active investment. Plus, over the past few years, index funds have outperformed managed funds.
The best part is that you don’t have to be an expert in the stock market for you to invest in index funds.
Here are some of the reasons why you should invest in the stock index:
- Less risk – Investing in the indices involves hundreds of stocks. This kind of diversification makes it less likely to incur significant losses if something happened to one of the companies.
- Wide range of investments to choose from – You’ve got a choice to either buy the stock index funds or the mutual index funds. You also have the option to buy a more focused index fund that concentrates on specific areas of the financial market.
- Relatively Cost-effective – The stock index is considered less expensive. You only have to buy the stock without the need to pay the stock manager for any kind of advice they offer to you.
- Less Tax – The stock index doesn’t actively involve buying and selling holdings. This feature ensures that you don’t generate capital gain that will require taxing.
How to Invest in Stock Index
Now that you know what a stock index is and why you should opt to invest in it, it’s time to understand how you can invest in them. The following are simple steps to help you know how to go about it.
Decide Where to Buy
You can use two places to buy your stock index – a mutual fund company or a brokerage. If you wish to invest in Kenya without using a mutual fund or a broker, you could use indices on the NSE as a guide.
Ensure that the approach you take meets your needs. That means you should first understand the kind of investment you want to make, as well as your expectations. Whatever the case, always ensure that you keep your expectations realistic.
Also, check on their trading cost, transaction process, and any commission fee waivers by the provider.
Never fail to consider the kind of fund selection you want. If you choose to work with a big mutual fund company, you ought to know that they offer some of their competitor’s funds. However, if you go with a brokerage, have in mind that your selection will have more limits.
Choose The Index You Want
It’s good to understand that the index mutual fund tracks different indices. Let’s say you wanted to replicate an index in the Kenyan stock market, there are several indices to consider.
There is the NSE 20 share index, a benchmark that tracks the top 20 listed equities. The FTSE NSE 15 Index tracks 15 stocks at the NSE ranked by company’s market capitalization, while the FTSE NSE 25 Index tracks the most liquid 25 equities at the NSE.
For instance, the most common index in the US is the Standard & Poor’s 500 index. This index tracks 500 companies, which comprises large, well-known companies based in the U.S. Vanguard has a stock index that tracks the S&P, the Vanguard S&P 500 ETF. And this is just one of the investment companies with mutual funds that track the S&P 500 or other indices.
That said, ensure you do your due diligence and invest in a stock index that meets your investment objectives. Alternatively, you can hire a professional to help you.
Once you select your index, you can easily customize your allocation if you wish to explore a particular market in the portfolio.
Below are more of the options you’ll have:
- Size of the company – These are index funds that track the large, small, and medium-sized companies.
- Geography – The index funds track both foreign, international exchanges, and a combination of both.
- Industry – These are funds that track business sectors such as health, technology, and consumer-goods related businesses.
- Market Opportunities – These are index funds that track emerging business opportunities in the market.
Check the Investment Minimum
One reason why people prefer investing in the stock index is its affordability. They’re cheap because the index is automated to follow the shift in value.
When investing in the stock index, you’ll be required to pay some administrative fees, even though no particular team manages these indexes. The administrative cost is subtracted from the shareholder’s fund returns coming from their overall investment total. Still, the fees are less than what you’d pay with an active portfolio of stocks.
Before investing in a stock index with any mutual fund, get to know the minimum cost required to qualify to invest. Additionally, it would help if you ascertained the expense ratio, which is the cost subtracted from each shareholder’s funds.