Benefits of Indexing

Indexing allows the investor to be more diversified than a traditional stock portfolio. Most index funds comprise of a large number of companies, for example, S&P 500, Russell 1000, and Russell 2000.

Index funds have had very good performance in the past. They have done better than active stock picking. In shorter investment periods, active management has done better, but that is before you factor in transaction costs. With active management, you are constantly buying and selling. Merely looking at returns is insufficient. The investor must look at net returns. Sometimes, it is quite difficult to compare actively managed portfolios. If the investor has few stocks or funds in the portfolio, there are no comparable benchmarks that can be easily created to check your performance compared to the market. With index funds, the investor has numerous benchmarks to compare his or her portfolio performance.

Index funds are far cheaper compared to the cost of transactions involved in a portfolio with frequent portfolio turnover at certain brokerage firms. It is also cheaper than owning most mutual funds. Index funds also have low expense ratios. Since these funds do not engage in costly investment research, they manage to keep their expenses relatively low. With more and more ETF companies emerging, these expenses will get even lower.

Another great benefit of Indexing that most investors overlook is tax efficiency. Indexing’s buy and hold approach may also substantially reduce capital gains tax liabilities compared to most actively managed funds.

There is a lot of confusion among investors regarding what securities they own. Indexing creates transparency. With most index funds, it is very easy to view the holdings. In the prospectus, they usually list all of their holdings.