Is An Index fund A Diversified Investment?
We need to know and understand first what is diversified investment. Diversified investment means that portfolio of different kind of assets which earns high return for less risk. It can happen because to the same event of economic, stocks, commodities, and fixed income as assets will reach differently. Stocks, commodities, and income in other words do not correlate each other. When stocks rise, for example, fixed income may fall.
It is different with diversified investment. In this kind of investment, some classes of asset will benefit no matter how the economy is. It means that there is a reduction of risk of portfolio because they balance the others losses. Furthermore, single event cannot wipe out the portfolio. To defend yours in a financial crisis, diversified investment can be a good choice.
How it Works?
When economy grows, stock do well. Investor will bid up the stocks prices since they want the return at the highest point. A bigger risk will be accepted by them since they feel optimistic for it. They believe that the future will be great. In the other hand, when economy slows, bonds and also other fixed income will do well.
They tend do something to protect their asset. they are ready to get lower return instead of taking the risk. In term of commodities, they vary with demand and supply. Oil, gold, rice, wheat, and other commodities will vary with them. they are different with the matter of stocks and bonds. The business cycle phase doesn’t closely affect commodity.
Index fund is kind of mutual funds designed to track particular index performance. It is mutual funds which constructs portfolio to track or match components of market index. This is kind of popular way of participating in stock market and portfolio diversification. It has some advantages compared to direct ownership of securities.
How they differ? Actually index fund is kind of passive investment. Lower management ratio of expense is the major advantage of index fund. While direct ownership of securities or actively managed fund need to use research team, index funds do not need it.
Is an Index Fund a Diversified Investment?
This questions can be answered if index funds have six asset classes. The first is US stock (including small, mid, and large-cap), the second asset is US fixed income (for examples: US treasuries and saving bonds or Municipal bonds). Then there is Corporate bond (which provide return in higher point with greater risk).
Foreign stock (includes companies from emerging and developed market), foreign fixed income and commodities are other assets. Since index funds track a bundle of commodities, stocks and bonds, they provide diversification which is more than individual securities.
The popularity of index fund Is because some advantages. It is less expensive than directly owned underlying securities. They liquidity is also a matter which make index fund has more advantage. The share of index fund is bought and also sold every day on major exchange. Shares of buying and selling of an index fund is faster than that of underlying shares. It also more convenient. In addition, index is one of best ways to get returns of broader-market. It is a way to maximize the returns of portfolio.