Are Index Funds Good for Long Term Investment?


If you’re considering investing in index funds, you’ll want to know if these funds are suitable for a long-term investment. Index funds are an excellent option for beginners since they are pretty low risk and allow you to experiment with investing. However, can you hold them for a more extended period?

Yes, index funds are great for long term investment. These are low risk passively managed diversified securities with a history of beating most actively managed investment funds in the long run. Furthermore, for being passively managed, index funds offer some of the lowest expense ratios in the industry. 

You want to find index funds that are diverse but not expensive. These funds do better when you don’t actively manage them. Overall, they’re an excellent option for most investors to consider.

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Why Choose Index Funds for Long Terms?

When you invest in an index fund, you’re taking on less risk than if you were to invest in stocks or bonds. This benefit comes from index funds holding hundreds of securities. 

Your risk spreads over all those different securities, which might represent a very diverse set of businesses.

It’s very difficult for an index investor to lose all of their money, as all of the stocks in their index would need to drop their value for this to happen. That means several companies would need to be bankrupt at the same time. 

You’ll also receive some assets from their liquidation, lessening the impact.

Plus, if you hold these funds long enough, you will also start earning dividends, which could come either quarterly, monthly, or once per year. It all depends on the type of fund. 

When you earn dividends with index funds, you have the choice to either withdraw them or reinvest in the fund. 

Index Funds and Reinvesting

In many cases, the dividends will automatically reinvest into your index funds, giving them a further boost and an even higher value. Plus, next when it’s time for dividend payments, you’ll receive an even higher yield because the previous dividend’s value counts towards the new amount. This is commonly referred to as the compounding effect in  index fund investing.

In other words, the longer you have the index fund, the more exponentially it grows. If you’re unfamiliar with compounding, this quick YouTube video sums it up nicely:

According to Investopedia, indexes also do much better in the long term. They produce higher yields than most other portfolios, even when you consider all the fees and costs associated with index fund investments.

When To Start Investing in Index Funds?

What is the best time to start investing? The sooner you invest, the more money you’ll have down the line. If you’re younger, you should invest as quickly as possible, so your savings and investments have ample time to grow. 

The best strategy is to invest and have your dividends automatically reinvest into the funds. 

Then, you’ll need to learn to manage your reactions so you don’t remove money from the funds too early. You should wait several years with this strategy, as patience is key!

In the past, index funds from the S&P 500 consistently outperformed many private funds, making it a fantastic option for everyone. The sooner you invest, the sooner you start to see the benefits. If you can support more, your yield will increase much faster.

There are also some index funds that you can easily invest in for the short term. Although, many professional investors say to not touch index funds unless you can wait for at least five years.

How To Start Investing in Index Funds?

When you’re ready, you’ll want to start by investing small amounts, such as $100 per month, which is a great start. As you make more money or start feeling more comfortable with investing, you can always add more. 

The index fund will continue growing, even when you can’t continue adding more money to it.

You must use index funds to diversify your portfolio, but since they consist of several different stocks, they’re naturally diverse. You don’t want too much of the same in case one of the indexes crashes suddenly. 

You can have various indexes that track obscure niche markets as well.

You can either open an account with a mutual fund broker or go directly through your bank to buy the funds. You’ll want to ask them many questions and determine which option is the best for you. 

Your broker can also help you set up reinvesting dividends, which is essential for long-term growth.

Profit Potential With Long Term Index Fund Investments

You can receive significant profits from long-term index fund investments. For example, the current average yearly return on the S&P 500 is about 10%, which means it would take about seven years for your existing investments to double in price. This is of course assuming that S&P 500 would continue to grow at the same pace. So, you’ll have to hold onto them.

However, once your investments do double, it becomes much easier and faster for you to earn higher reinvesting dividends. Many people choose to invest in index funds for their retirement because of the longer holding periods recommended for these instruments.

Although, anyone can significantly benefit from adding some long-term index funds into their portfolios. If you want to learn more on the topic, I recommend reading Index Fund Investing: A Comprehensive Beginner’s Guide from Amazon.com. The book should teach you the best methods to invest in funds and give you the skills you need to do so confidently.

How Index Funds Work?

Buying index funds isn’t as expensive as buying a diversified portfolio of whole stocks. With this method, you purchase the funds with other investors. From there, a fund manager takes the investment money and places it in the securities, where it should earn you a healthy return over the long term.

The index fund tracks one type of market index. 

For instance, your fund might follow the S&P 500 Index. Essentially, the index fund you have should mirror a market’s performance, so you can build your investment strategies around that fact.

The longer you hold onto the funds, the more money they make and you’ll receive a return on the funds you hold. It can take a while, but the longer you have them, the higher that yield is.

Overall, there are plenty of ways to use index funds to diversify your portfolio. You’ll want to ensure that you have index funds from various markets. If one were to drop its value suddenly, you would still have alternative investments at play.

Benefits of Index Mutual Funds

There are several benefits to owning index funds, which factor into how useful they are for holding in the long term. 

These benefits include all of the following:

  • Low levels of risk.
  • Consistent and steady growth.
  • Low fees and commissions.
  • Follow their set indexes.

You can expect to notice plenty of benefits when you invest. 

The fees are extremely low since you don’t have to pay anyone to manage the investments actively. Because of this benefit, as opposed to some actively managed funds, you can break even with a very modest return. Plus, technically, it is unlikely and near impossible for an index fund to lose all its value.

Overall, these benefits make index funds well worth investing in, especially for a long term investment horizon. You get several features and ways to earn more money. They’re great for beginners, but investing veterans can benefit profoundly from having them in their portfolios as well.

Author’s Recommendations: Top Trading and Investment Resources To Consider

Before concluding this article, I wanted to share few trading and investment resources that I have vetted, with the help of 50+ consistently profitable traders, for you. I am confident that you will greatly benefit in your trading journey by considering one or more of these resources.

Conclusion

In short, I’d recommend that everyone choose index funds for long term investments, as they work wonderfully for long term horizons. You receive dividends, which can automatically reinvest, earning you a solid compounded growth. 

Plus, the funds work even better when you add them to a diverse portfolio.

There are many different sides to index funds. If you want to learn more, I recommend that you stick around my website. There’s a ton of great information and sources there for you to use to further your understanding of this investment instrument.

BEFORE YOU GO: Don’t forget to check out my latest article – ‘7 Proven Steps To Profitable Trading. I surveyed 5000+ traders (and interviewed 50+ consistently profitable traders) to identify 7 statistically proven steps that will help you become a consistently profitable trader. No matter where you are in your trading journey today, I am confident that you will find this article helpful!

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    1. If index funds perform better, why are actively managed funds more popular? (n.d.). Knowledge@Wharton. https://knowledge.wharton.upenn.edu/article/if-index-funds-perform-better-why-are-actively-managed-funds-more-popular/
    2. Index fund. (n.d.). Investor.gov. https://www.investor.gov/introduction-investing/investing-basics/glossary/index-fund
    3. Index funds and the future of corporate governance: Theory, evidence, and policy. (2018, November 28). The Harvard Law School Forum on Corporate Governance. https://corpgov.law.harvard.edu/2018/11/28/index-funds-and-the-future-of-corporate-governance-theory-evidence-and-policy/
    4. Investor bulletin: Index funds. (2018, August 6). SEC.gov. https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_indexfunds
    5. What is the average annual return for the S&P 500? (n.d.). Investopedia. https://www.investopedia.com/ask/answers/042415/what-average-annual-return-sp-500.asp

    Navdeep Singh

    Navdeep has been an avid trader/investor for the last 10 years and loves to share what he has learned about trading and investments here on TradeVeda. When not managing his personal portfolio or writing for TradeVeda, Navdeep loves to go outdoors on long hikes.

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