Index investing can be a great tool for veterinarians to utilize. Index investing refers to buying an “index,” such as the broad stock market, using a single investment. For example, buying the “market” is a popular way in which index investing can be achieved. By purchasing shares of a market-based index fund, just like purchasing a stock, you get access to the entire S&P 500 (the largest 500 companies listed in the U.S.). This can act as a great diversifier for someone who does not want to pick individual stocks but would rather have returns that closely mirror the market as a whole.
Index funds can come in a variety of flavors that track different indexes. Investors cannot invest directly into indexes themselves, so index funds, which are offered in the forms of mutual funds or exchange traded funds, are particularly useful for a busy veterinarian who wants to invest in the markets, but doesn’t want to get into the granularity of researching particular stocks.
An additional benefit of index investing is that companies that offer these products have done so at very low-fee levels—theoretically making the returns of the actual index and the fund similar. A popular approach is to “layer” these index funds so that a portfolio can be constructed using various index funds to achieve ones investment profile. However, index investing is not a perfect solution and there are negatives to this approach.
Not all funds are created equal
When you invest in an index fund, you own shares of every company in the underlying index. Some of these companies might not be terrific investments for many reasons, but they are in the index, so you own them. Also, not all index funds are created equal. For example, there are funds that assign weightings based on the size of the constituents. For companies with large market capitalizations, you will own much more of them than you will of the smaller companies.
There are also index funds that place equal weighting on all of the constituents in the given index so that the size of the companies has no implication on the weightings themselves. The downside to these “equal weighted” index funds is that the fees tend to be higher.
In addition, it’s important to realize that indexes can change as companies are added or removed based on index specific criteria. Index funds also can change the index they are tracking, which can inherently change the holdings in the index fund. Most importantly, index investing is a tool that can be used to assist in reaching financial goals. It does not prevent against losses or attempt to time the markets using any complex techniques.
Eyes wide open
As with everything you invest in, it is very important for you to understand exactly what you own and the risks associated with it. Index investing can be used to pursue portfolio diversification and access areas of the market in which investing in individual securities could be burdensome or inefficient. Different indexes have different risk profiles and should be invested in accordingly. Make sure to understand the actual index that the fund is supposed to be tracking as that is the main driver of total returns.
Miles Saunders is the founder of MNS Wealth Management. Visit mnswealthmanagement.com.