What are index mutual funds?

Index mutual funds are simply mutual funds that track a market index such as the S&P 500, Wilshire 5000, or Barclays US Aggregate Bond Index. 

Fund management is totally automated, so the expense ratios are much lower than for most actively managed funds. In fact, in most cases the expense ratios are less than 0.50%.

Like other mutual funds, index funds are typically bought and sold at the end of the day, which means that you don’t have a lot of control over the price at which you buy or sell. 

The good news is that, with few exceptions, you can buy them direct from the mutual fund company, so there are no brokerage fees.

Indexes are theoretical "baskets" of securities that are designed to reflect the performance of some segment of the securities markets. 

Indexes can be evenly weighted, such as the Dow Jones Industrial Average, or capitalization weighted, such as the S&P 500. 

There is no entity that actually owns the securities that make up an index, thus the performance of the actual indexes does not include any transaction costs. 

The prices of the securities in the indexes are aggregated daily and published, thus providing benchmarks or baselines that are used as a proxy for the performance of the market segments they track and to evaluate the performance of securities and investment portfolios that are similar in composition to the indexes.

Index mutual funds that track equally weighted indexes may own all of the securities that comprise the indexes they track. 

But Index mutual funds that track capitalization weighted indexes rarely, if ever, own all of the securities that comprise the indexes they're designed to track. 

Rather, they use statistical sampling techniques to assemble portfolios that include representative subsets of the indexes that have a very high probability of approximating the performance of the indexes. 

The reason that they employ this technique is that the transaction costs of constantly buying and selling shares of all the securities that comprise an index to maintain the exact index weighting would be so great that the performance of the funds would significantly lag that of the indexes. 

For instance, the stocks that make up the S&P 500 are constantly changing and the weightings of those stocks also change, usually on a daily basis. 

The transaction costs of maintaining a portfolio that was a mirror image of the index would be prohibitive.

There's quite a bit of controversy regarding the efficacy of index mutual funds. Some, like John Bogle of Vanguard, strongly advocate the use of index funds. 

Others, like most of the managers of actively managed mutual funds, insist that investing in index funds is a sure way to achieve mediocre performance.  Both sides have some valid arguments.

The best option before diving into Index Mutual Funds would be to research your options and speak with a professional.

If you are considering Retirement Planning, call for a free consultation today.