Updated: Mar 15, 2022
You may be wondering, why would I invest in an index fund or an Exchange Traded Fund (ETF) when I can buy an individual stock or a commodity (e.g. gold, oil, or precious metals) to meet my financial goals? First let’s step back to define what is an Index Fund or an ETF? Think of an Index Fund or ETF as a basket of stocks that make up the stocks that are traded on an Index like the Dow Jones or the S&P 500. It could also be an investment sector like Technology or Energy, and it tries to have the same performance of the index or sector that it is tracking. What makes the Index Fund or the ETF attractive is because of its diversity of investments. It has so many stocks in the fund that it provides some level of cushion to help manage the big swings that may come from owning individual stocks or commodities. Investing should be long-term. Unless you are into trading stocks and commodities, when using Index Funds and ETFs, you can usually set it and forget it.
I will illustrate using the investment action that took place in the Energy Sector on March 9, 2022. The Energy Sector is very sensitive right now due to the Russia-Ukraine war and because Russia is a major producer and exporter of oil on the global market. The war brings supply concerns that might affect the price of oil.
Table 1: Investment Type Comparison Table
As you can see with this example, the price swing in just one day was very big depending on your investment. All types of investments lost value on this day, however due to the diversification of the investments in an Index Fund or ETF, the % swing was not as big as it was by owning the oil commodity or by stock ownership in a company like Exxon Mobile. Of course, the opposite also would be true for an increase in value. The commodity or individual stock would increase in value by a greater percentage than the Index Fund or ETF.
However the thing to keep in mind is that you can reach your wealth-building goals without having to experience the big price swings that may come from owning an individual stock or a commodity. With an Index Fund or ETF, the price swings are not as big, and the average investment returns over time will help you achieve your financial goals and keep your wealth-building on track. Index Funds and ETFs provide some peace of mind so that you can stay focused on your job, business, or the things that you enjoy while your investments continue to work for you. Slow and steady wins the race.
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