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How Safe are Indexed Funds

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An indexfund is a vehicle that is designed to be a safe or fool proof method ofinvesting in the stock market. This level of safety is supposed to be achievedby investing in an index a list of stocks that meet certain criteria ratherthan active stock picking.

 

IndexFunds 101

Atraditional mutual fund is actively managed that means a manager or team ofmanagers picks the stocks that it invests in. An indexed fund is automaticallymanaged only stocks that meet the criteria are purchased. Any stock that cannotmatch the criteria is automatically sold. Nobody actually makes a decision tobuy or not to buy anything.

 

The most commonmethod of indexing is stocks from the largest companies that meet a certaincriteria. An S&P 500 would invest only the stock of the 500 largestpublicly traded companies in the United States. In addition toeliminating human shortcomings from the investment process this is supposed tooffer diversification. The S&P 500 fund would invest in a wide variety ofindustries which would theoretically shield it from losses.

 

Index fundscan offer a high fairly stable return over time. If Jeannie invested $5,000 inan S&P 500 index in 1980 and kept it until 2011 her funds would have grownto $39,651 based on an averagerate of return of 12.61%.There are some risks from indexes that you should be aware of.

 

PotentialLosses from Indexes

The bigproblem with indexes is that they can be very vulnerable to market fluctuationsand bear markets. An S&P index fund have lost 37.22% of its value in theyear 2008 because of market losses. Yet it would have regained all of thoselosses over the next few years.

 

That meansan index fund is an excellent long term growth investment but not a good methodof parking money. You should put funds you may not need until years in thefuture (such as your retirement nest egg) in such vehicles. You should neverput the money that you might need real soon in one.

 

Index fundscan be particularly dangerous for persons saving for retirement withnon-insured vehicles such as IRAs and mutual funds. Such people can lose all oreven most of their investment through market volatility. These funds can alsobe very bad for retired people that are relying on investments for a largepercentage of their income. If most of Jeannie’s money had been in an S&Pindex in 2008 she would have lost most of her savings.

 

AnIndexed Fund that Offers More Protection

There is away that you can invest in indexed funds and get an added layer of insuranceprotection and increase your amount of tax deferred income. An indexedannuityis a hybrid investment that combines an indexed fund and a fixed-rate annuitycontract.

 

The way itworks is that some of the money is invested in the index through a sub account.Some of the funds are also invested in a fixed-rate annuity which providesguaranteed income. This will provide the annuitant with some income. Any profitmade from the index is reinvested in the annuity so it will not be lost andhave insurance protection. This can grow your retirement nest egg whilelowering the risk. Any gains would be tax-deferred because all money investedin annuities is tax-deferred. That means no taxes are due until the moneyleaves the plan.

 

Thisarrangement is not perfect but it can reduce the risks associated with indexedfunds. It can also provide an investment that effectively manages itself.Persons interested in any sort of indexed investment should always carefullyresearch them before buying one. There are serious risks associated with themeven though they are very safe investments.

 

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