For anyone who is unaware of what an Index is, it is predominantly a measurement of value of a specific section of the stock market. There are number of ways of calculating this value, one being computation from prices of pre-determined selected stocks. This can also be referred to as a statistical measure that quantifies the changes in values of list of prices of the stocks, which represent the whole market.
These Indices also assist with measuring the all over performance of the stock markets around the country. Despite all these, the index figures do not magically appear. One can come across various organizations, which specialize in index services. These organizations are termed as index providers or simply an Index Company. Their expertise lies in not only index calculation but in index development and maintenance of the same. These organizations make sure that they mirror any changes in the market, economy and all investors' sentiments.
The basics of indices being covered let us move on to investment strategy that is a direct result to indices. Investors of our time are well acquainted with terms like Index Investing. Here what one does is simply invest in Index Funds. These funds can be analysed as mutual funds that have their base on specified indices and one creates a portfolio, which reflects the performance of the indices.
Similar to index funds, mutual funds are designed to beat the performance of stock market by branching out the investment. Despite all that, almost all of the mutual funds fall short of outperforming the market index. The main reason behind under performance of mutual funds is the cost that mutual funds charge. Funds that are managed actively in this manner are prone to charging the investors more for the sake of covering their own cost.
The major advantage of index funds is reduced management fees. This aids in bigger returns than most funds that are actively managed. Since, index funds follow the familiar trend, they tend to spend less. This is mirrored in the total return(s) of the fund(s). The reasoning behind this lowered cost is that the fund is not an actively managed one. All that, fund managers are required to do is to maintain the weightings as applicable of the stocks in selected index to replicate its performance.