Rising inflation and the war in Ukraine have contributed to stock market volatility. They have also raised the question of a possible market crash which, fortunately, has not materialized so far. When faced with such volatility, rather than panic selling, I like to take a more stoic approach and learn from my mistakes and those of other people. And what better time to do it than in the last few months? Let’s take a look at what index funds are and the four reasons I continued to invest in index funds during the recent market sell-offs.
What are index funds?
An index fund is a type of Investment fund (ETF) or Investment fund which is designed to mimic the composition and performance of a market index (for example, the FTSE100). For this reason, index funds are also called passive funds. So if the benchmark that the fund mimics rises in value, so will the fund.
On the other hand, we also have funds that are actively managed by portfolio managers. Your job is to choose which stocks will make up the fund’s portfolio and your only goal is to try to outperform the market. If the fund manager makes poor investment decisions, this will cause the fund to underperform the market, essentially resulting in losses for investors.
So with that in mind, let’s take a look at four reasons why I continued to invest in index funds despite market volatility.
1. Low costs
One of the reasons I continually invest in index funds is their low expense ratio. In a nutshell, this is what a fund charges for administrative fees, including maintenance, reflected as a percentage of the fund’s average net assets. This means that if the fund I invest in has an expense ratio of 0.10%, I will pay a fee of £1 for every £1,000 invested. And the best thing is that this is automatically deducted from my returns, so I don’t have to think about it too much.
2. Tax efficiency
In the UK, every time you make a profit by selling a security at a higher price, you are required to pay Capital gains tax. Because of the way the funds are set up (to mimic a benchmark), they don’t actually do a lot of trading. This means that they do not generate a large amount of capital gains. In the event that a fund sells an underlying share for a profit, it must pass the proceeds on to its shareholders as a distribution at least once a year.
3. Benefits of regular investment
Investing in volatile markets is quite a stressful and complicated task, especially if you are trying to time the market. Instead, I figured out an amount I’m comfortable with and invest it every week in a variety of index funds. Take a long-term approach It has really helped me stay put during the most chaotic weeks. In theory, by averaging the cost of the pound over a long period, you should be able to weather any future market volatility as long as you keep investing in index funds.
Creating a balanced portfolio is a challenging task. However, recent events have once again shown that a diversified portfolio can protect an investor’s wealth. Investing in index funds is basically owning a piece of many companies in different industries. So, in practice, you’re already diversified by buying multiple index funds.
Personally, I have spread 90% of my investments in index funds and I keep 10% for the selection of riskier stocks and companies. In this way, I have a wide exposure to different asset classes and securities.
If you want to invest but aren’t sure where to start, check out our investment basics.
Please note that this article is for informational purposes only and is not intended to recommend any particular investment strategies.
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