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Indexing

If you want to invest, but don't have time to choose individual stocks, indexing may be the way to go. By buying one index fund, you can own small bits of hundreds of companies.

Some investors want to beat the market. Their goal is to get higher returns on individual investments than what they could get by simply owning an index fund that tracks the same type of investments. So they trade actively, trying to own the right investments at the right time. Beating the market is a nice thing, if you can do it, but the truth is that most investors can't.

Instead of trying to beat the market, one strategy to consider is called indexing. With indexing you invest in a number of exchange-traded funds (ETFs) or mutual funds (or both). Each fund owns the same investments that are tracked by a specific market index. Investors buy these funds because you can't invest directly in an index. Nobody can. And, in any case, it just doesn't make sense for most investors to individually own the 500 stocks in the S&P 500 or the 2000 in the Russell 2000. Instead of buying each of the stocks in the S&P 500 index, you can just invest in an index fund that owns these investments.

To put indexing into practice, you may consider gradually building a diversified portfolio of index funds, allocating some of your principal to stock indexes and some to bond indexes. As you begin, you could focus on a few well-known indexes in each asset class that cover different segments of the market. In the case of the S&P 500, that means large company stocks and small-company stocks in the Russell 2000, for example. With your Capital One Investing account, you can reinvest your earnings to buy more shares.

As you invest more, you can think about branching out to smaller or more specialized sectors of the market or funds that track international indexes. Something to keep in mind is that narrower indexes may be less diversified and, in the case of ETFs, may be less liquid because they're traded less frequently. That means that they may be more volatile and harder to trade, and thus, more risky.

Some advantages of indexing

One advantage of indexing is that it's less expensive to own index funds than actively managed funds because the expenses are typically lower. This is usually easier and cheaper than trying to create a well-diversified portfolio of individual securities from scratch. Quick note: diversification does not guarantee a profit or protect against market losses.

Also, because an index fund makes changes to its portfolio only when the components of the index are changed, sometimes as infrequently as once a year, index mutual funds also tend to be more tax efficient than actively traded mutual funds.

And a disadvantage

One drawback of index investing is that in a down market, index returns are down too. There's no investment manager to shift focus to investments that are doing better than the pack. And - you knew this was coming - past performance doesn't guarantee that index funds will always recover from a market downturn.