Hundreds of indexes track changes in the financial markets. Some are narrow measures of a specific sector or industry, such as indexes that track clean technology or consumer goods stocks or the securities of a particular country. Others are broad gauges of overall market activity and are considered bellwethers of the health of the economy. For example, the market value change in the benchmark Standard & Poor’s 500 Index, or S&P 500, which follows 500 widely held U.S. stocks in leading industries, is one of the ten components of the Index of Leading Economic Indicators, the primary measure for forecasting changes in the economy.
With the important role that indexes play in the financial markets, it’s no wonder some people think that an index might be the perfect investment. The trouble is, you can’t invest in an index. It’s a statistical calculation, not a security. And it’s not for sale. But there are some investment alternatives.
Index-based investment products, including index mutual funds, exchange traded funds (ETFs), and unit investment trusts (UITs), are all designed to mirror the performance of a stock or bond index, from the very narrowly focused to the very broad. While these investment products are each constructed differently, they share some basic characteristics that can make them attractive to investors:
Easy diversification: By purchasing a single investment, you gain exposure to the entire segment of the market covered by the underlying index.
Transparency: Investment in an index-based product means you know what underlying stocks or bonds make up your investment.
Cost efficiency: Because most index investments are passively managed, their holdings change only when the securities in the underlying index change. That means they incur fewer management, research, and trading costs than actively managed funds making similar investments.
Tax efficiency: The low turnover rate in most index-based portfolios results in fewer capital gains distributions, making index investments tax-efficient.
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