With time, new tools are introduced to the financial market with enhanced functionalities and which are more flexible, profitable and less risky. Enhanced Index Funds (EIF) are one of such new products which facilitate traders to get better returns from markets
What is Index Fund
Index funds are a great way for investors to invest and let go of their investments for a long time. They are portfolios with a wide spectrum of stocks or other investment ways. They provide, in numerous cases, diversification for peoples seeking rather safe and least volatile portfolio. Nevertheless index funds do not offer out-performing benefits, they do enable an investor to sit back at home and allow the fund move itself for the long term.
Active Index Fund
Enhanced index funds are a type of mutual funds which is also termed as Active Index Funds or AIF. These index funds often outshine the normal index funds by effective management of the fund portfolio. EIFs are more profitable based on many means.
- By carefully organizing the position sizes or allocation to a sector.
- By keeping an eye on the market entry and exit timings.
- By investing only in specific securities of the index which comply with certain rules.
- By avoiding those securities which are inclined to under perform.
- By minutely leveraging other tools.
- By frequently changing the investment preferences and portfolio allocations with change in market trends.
EIFs trades like any other index funds but with two specific differences. First is, they engage management risk - the risk incurred as a result of (ineffective) active fund management. All common index funds have only market risk - risk arise as a result of market tend - but EIF considered both market and management risks. Second is the huge fee. Although in the lower side than most mutual funds, but EIFs have higher fees involved than normal index funds.
Investing in EIFs can have its own advantages and disadvantages.
Advantages of EIFs
- Higher return compared to most other index funds.
- Enhanced portfolio diversity and lower risk factor.
- Lower expense than most mutual funds.
- Suitable for any type of investors.
- Benefits from semi-active fund management which facilitates investors to profit from changing market trends.
Disadvantages of EIFs
- Involve more risk than other index funds.
- High expense ratio than other index funds.
- No ample performance record available as they are newer instruments.
- Risk of losing capital due to ineffective fund management.
Investors are suggested to carefully select EIF after properly understanding the funds asset allocation and active management planning.
What is Mutual Fund Index
A mutual fund index is an investment profile that matches a target "index". Common indices embodies Russell 2000, Standard and Poor's (S&P) 500, Wilshire 5000 etc. This investment portfolio is possibly the most famous mutual fund option available before the investors.
Other benefits of Index Funds
- Although it's generally opted by small investors, index funds appeal to a wide spectrum of investors due to their advantages.
- Most remarkably, an index such as the S&P 500 has through out out-performed other actively handled portfolios. How’s an unorganized fund managed to outshine wall street professionals?
- The fund virtually has lower expense ratios, which goes to say that the real returns become magnified in the long run. On an average, the expense ratio is approx.1.9% for most non-indexed funds. However, with an index, you'll notice the ratio close to 0.1% expenses. This is the result of low maintenance involved in handling the portfolio. It takes less time and resources to organize this type of fund.
- Investor of index funds also enjoys the tax advantages associated with this type of investments.
- Since they just reproduce a benchmark, there are lesser transactions, or fewer turnovers.
- The costs of transaction of stocks, bonds or cash reserves are much less than an actively organized portfolio that sells investments much more often.
- This goes to show that the investor displays low capital gains due to stock sales.
- Eventually, low turnover means fewer costs to the investor.
- Diversification is another core benefit. If you analyze an index like Wilshire 5000, you'll notice stocks that fall come into so many separate categories.
- As one can realize, the index holds almost 5000 various stocks that range from small capitalization stocks to big tycoons like General Electric.
- A fund that holds, suppose, 100 stocks may be exposed to more vulnerability than this Wilshire 5000. As you can see, this fund would offer better stability.
Inspite of several advantages, index funds are not completely perfect. The biggest setback is that their performance is simply influenced by the market trend. If Dow Jones goes up, then the S&P 500 Index also shoots up. However, if the market faces a dramatic downturn, the same trend will be noticed with S&P 500 index. Eventually, the fund stands no chance of beating the stock market; it simply follows the market trends.