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Index funds are a great investment option for building wealth over the long term. If you’re unfamiliar with this term, an international index fund is simply a type of mutual fund or exchange-traded fund (EFT) that aims to replicate the performance of a specific global market index. These funds will invest in a diversified portfolio of stocks from various countries outside of the investor’s residential country.
As with any investment, there are both benefits and risks associated with an index fund strategy. Throughout this blog, we explore all of the complexities.Â
How do index funds work?
Index funds operate on the principle of passive management. Unlike actively managed funds where fund managers make decisions about buying and selling individual stocks, index funds follow a set strategy based on the underlying index. The fund manager's role is to ensure the fund's portfolio mirrors the index as closely as possible.What are the benefits and risks?
Any aspect of investing comes with benefits and risks. We’ve explored what these look like for index funds below:Benefits
- Simplicity: Index funds offer a straightforward way to invest in a broad market segment without needing extensive market knowledge.
- Lower Fees: Passive management leads to reduced costs, enhancing net returns over the long term.
- Consistent Performance: By mirroring the index, these funds tend to perform consistently with the market.
- Transparency: Investors can easily understand what they are investing in since the holdings mirror a known index.
Risks
- Market Risk: As with any investment tied to the stock market, international index funds are subject to market volatility and can experience declines during market downturns.
- Currency Risk: Investing in international markets introduces the risk of currency fluctuations, which can impact returns when converting back to the investor's home currency.
- Political and Economic Risk: International investments can be affected by political instability, economic changes, and regulatory differences in foreign countries.
- Limited Flexibility: Because they follow a set index, index funds do not adapt quickly to market changes or take advantage of short-term opportunities.
Who should invest in index funds?
Anyone can invest in index funds. However, the most suitable market segments are often:- Long-Term Investors: Those looking to grow their wealth steadily over time with minimal intervention.
- New Investors: Individuals who are new to investing and seek a straightforward, low-cost way to enter the market.
- Busy Professionals: People who do not have the time or expertise to actively manage their investment portfolios.
- Risk-Averse Investors: Those who prefer a diversified and balanced approach to investing, minimising the risk of significant losses.
Why should you invest in index funds?
Unlike actively managed funds that aim to outperform the market, index funds seek to replicate the market's performance by holding a portfolio that mirrors a specific market index. This means they invest in all the stocks that make up the index in the same proportions. This approach is known as passive management. With index funds, there's no need for constant buying and selling of securities based on market predictions. Instead, the goal is to achieve returns that match the overall market performance. This can be particularly advantageous for balancing risk in an investor’s portfolio, as the collective performance of an index tends to be more stable and less susceptible to the volatility that individual stocks might experience. Other reasons to choose index funds include:- Diversification: By investing in a wide array of international stocks, these funds provide exposure to different markets, industries, and economies, reducing the risk associated with being overly concentrated in a single market.
- Global Growth Potential: International markets, particularly emerging markets, can offer higher growth potential compared to more mature domestic markets.
- Risk Mitigation: Diversification across various geographic regions can help mitigate risks related to economic downturns in any one country.
- Cost-Effective: International index funds typically have lower fees and expenses due to their passive management style.
- Choosing the right index fund: There are a few factors to consider when choosing which fund to invest in. Often, this comes down to cost. Low costs are often one of the biggest selling points when it comes to index funds as they’re more affordable as they’re automated to follow the shifts in the value of an index. However, don’t forget that they still carry administrative fees. Two funds may have the same investment goal yet have administrative costs that vary significantly. Generally speaking, the bigger the fund, the lower the fees.
How do you get started?
If you’re ready to enter the world of index fund investing, we’ve outlined an easy path to follow:- Define Your Goals: Determine your investment objectives, time horizon, and risk tolerance. Keep in mind that index funds are potentially a good way to let your money grow slowly over time and in most instances, it’s more of a long-term strategy.
- Research Funds: Look for international index funds that align with your goals. Consider factors such as the fund’s expense ratio, the specific index it tracks, and its historical performance. You may also want to consider market opportunities to examine emerging markets or growing sectors.Â
- Open an Account: You need to open an investment account with a brokerage firm that offers access to international index funds. Make sure you shop around as brokerages vary. Consider:
- Convenience: Finding a single provider that can service all of your needs.
- Fund selection: Consider if you want to purchase index funds from various fund families.Â
- Trading costs: Costs will vary and sometimes, commission or transaction fees are waived.Â
- Impact-investing: Some companies focus on projects that make a difference outside of investments. For example, those with a social justice or environmental focus so consider where your values lie.Â
- Fund Your Account: Transfer funds into your investment account to prepare for purchasing index funds.
- Purchase Shares: Buy shares of the chosen international index fund. You can opt for a lump-sum investment or set up a regular investment plan to dollar-cost average into the market.
- Monitor Your Investment: Periodically review your investment to ensure it continues to meet your goals. Adjust your portfolio as needed, but avoid making impulsive changes based on short-term market movements.
