Investing in Mutual Funds that Track Stock Indexes

• There are many mutual funds that track stock indexes. These funds are generically called index funds. The first index fund was created by John Bogle when he founded the Vanguard Group. Today there are hundreds of mutual funds available that track almost any stock index.
  A stock index mutual fund attempts to replicate the performance of the index it tracks. It does this by buying shares of the same companies that are included in the stock index. If a mutual fund tracks the Standard & Poor's (S&P) 500 Index, the fund will buy stock in the 500 companies included in the S&P 500. Moreover, the mutual fund will buy the stock in the same proportion as the index. If Walmart is included in the S&P 500 and represents 1 percent of the index, the index fund will allocate 1 percent of its capital to Walmart shares. An index fund is periodically readjusted to keep its holdings in line with the index that it tracks.
  Investors can buy shares of index mutual funds. Index funds offer investors the opportunity to diversify their stock portfolio by owning stock in many different companies with just one investment. Index funds also offer very low fees. An index fund can have fees as low as 0.10 percent of the investor's capital.
  Some of the mutual fund companies that provide index funds are Vanguard, Fidelity, American Century and Franklin. These companies have index funds that track all of the major indexes such as the S&P 500, the Dow, the Nasdaq 100 and the Wilshire 5000. These companies also provide index funds that track sector indexes such as the S&P Transportation Index and the AMEX Semiconductor Index.
  
  

Investing in ETFs that Track Stock Indexes

• There are a wide variety of ETFs that track stock indexes. Like index mutual funds, ETFs that track stock indexes buy shares of the companies included in a particular index. Index-tracking ETFs have the same benefits as index mutual funds. The major difference is that ETFs can be traded throughout the day while mutual funds must be purchased or sold at the end of the day. This flexibility allows traders to trade in and out of ETFs any time during the trading day. Popular ETF families are Spiders, iShares, PowerShares and Direxion.
  Some index ETFs provide unique opportunities for investors. Inverse ETFs try to obtain the exact opposite result that the index they track produces. For example, if the S&P 500 returns 5 percent during a quarter, an inverse S&P 500 ETF will return approximately -5 percent. Investors can use inverse ETFs to hedge a portfolio against the threat of a decline or to make a profit during times of a decline in the index.
  There are also leveraged ETFs available. These ETFs attempt to double or triple the performance of the index they track. A double-leveraged ETF that tracks the Dow will increase by 4 percent if the Dow increases by 2 percent. Negatively, if the Dow decreases by 6 percent, this leveraged ETF will decline by 12 percent.