If you'd like to invest in stock without having to pick your own, buying a mutual fund can help you to build a diversified portfolio. When you buy a mutual fund, you're buying into a prearranged portfolio of stocks. This lets you spread your risk over multiple companies with the hope that the winners more than cancel out the losers, leaving you with an overall profit. A broad market index fund is a type of mutual fund that tracks a predefined list of stocks that cover a large portion of the overall market.
The Broad Market
A broad market fund owns the majority of companies that are traded in the U.S. For instance, a broad market index fund that tracks the Russell 3000 index would own shares in approximately 3,000 companies spanning 98 percent of the total market capitalization of U.S. companies. Funds that track the broader MSCI U.S. Broad Market Index cover 99.5 percent of the value of companies traded in the United States.
Index vs. Managed Fund
When a fund is designated as an index fund, it is structured to track an existing block of stocks, called an index. This is different from an actively managed fund, which has a stock picker choosing what the fund should own based on his projections and opinions. Index funds just track the index that is designed by a third party. In general, this makes the index fund easier, and less expensive, to manage.
Broad Market Fund Benefits
The benefit of buying a broad market fund is that your money gets diversified over many stocks. By owning a vast majority of the companies that are traded, you can expect to get the return of the entire market. This means that if any one large sector does poorly, another sector can balance it out. The secondary benefit of buying a broad market index fund is that you usually aren't paying high expense ratios. Index funds have lower fees than actively managed funds and, on average, end up delivering better performance, especially on an after-fee basis.
Broad Market Fund Drawbacks
All of a broad market fund's advantages are really the same as its drawbacks. When you own the whole market, you miss out on the opportunity to participate in the success of individual stocks or types of stocks. In addition to owning stocks in very conservative companies such as a consumer goods producer or an insurance company, you're also buying stock in small technology start-ups. Investing your money yourself in individual stocks or choosing narrowly focused funds might give you the opportunity to pick winners that could generate you more profit. Using an index fund also means that you aren't getting an expert stock picker to work for you.
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