Traditional index investing - through market-cap-weighted ETFs or mutual funds - can offer several significant benefits. To start with, index funds have a powerful advantage over most actively managed funds - lower costs. There are two main reasons for this. One is lower management costs as it simply costs less to manage and operate an index fund as they’re more scalable than active funds.
Additionally, active fund management tends to incur higher operating costs. Second is lower transaction costs. Index funds use a buy and hold approach, which means that index fund managers generally trade securities less often than active fund managers. Less trading reduces brokerage commissions and other expenses associated with trading securities. Managing a diversified portfolio is an essential part of a successful investment plan.
Indexing can be a simple way to achieve diversification. Thanks to their diversification and lower costs, index funds can be an effective way to achieve competitive returns over the long run. Index funds have a precise, easily understood objective, which is to track the performance of a specific index before fees and expenses. With index funds, you always know how your money is invested.
And finally, lower manager risk. Index funds reduce exposure to manager risk, which is the risk that poor security selection will cause underperformance. That's because they seek to track, not outperform, a market index. Active fund performance, on the other hand, is subject to more uncertainty.
