An index fund attempts to track the performance of an index. When the index goes up or down, the fund NAVPS/NAVPU should also go up or down by the same percentage.
Who should invest in index funds? Investors who:
- believe that over long time periods the index tends to go up. This is backed-up by historical data, but of course "past performance is not a guarantee of future returns".
- want to invest in the index but don't have enough cash to invest directly in stocks that make up the index. Replicating the index by buying shares in individual companies is quite expensive. Investing in a fund allows the investor to invest in the index for a relatively low amount.
- want to invest in the index but don't have the time or inclination to manage a portfolio of stocks. When the index composition changes, the investor should buy and sell shares to mirror the index's new composition. Investing in a fund allows the investor to "set-and-forget", in other words to invest and let the fund do the rest.
- want to invest in an equity fund with lower fees. Theoretically, an index fund should be passively-managed and have a lower annual fee than actively managed funds.
- believe they can outperform the market. Doing this is very difficult over a long time period.
- want control over which stocks to buy or sell.
- want control over when to buy or sell.
- Accurate index tracking - if an fund doesn't accurately track the index's movements, it's not an index fund. The deviation from the index is called the tracking error, the lower the better.
- Low fees - there's no reason for an index fund to charge a high fee
Index Funds Part 1
Index Funds Part 2