Index funds are a popular way for investors to diversify their portfolios without the hassle of trading to active investment. When compared to active investing, index funds offer investors an option of a low-maintenance, low-risk, low-fee investment vehicle. This makes index funds ideal for average investors looking to get exposure to new markets or diversify their current portfolio.
Recently, token index funds – or cryptocurrency-focused index funds – have stepped into the spotlight of investment. In this, we take a look at both traditional and crypto index funds and how they can be used to reap rewards without excessive risk.
What are traditional index funds?
An index fund is a type of mutual fund with a portfolio that’s built to match the elements of a financial market index. For example, the Standard & Poor’s 500 Index is an index fund. When you buy shares in an index fund, essentially you are pooling your money with other investors.
Investing in an index fund is generally a “safer” option for average investors because they offer wider exposure to different markets, require lower operating expenses and have a lower risk association. This type of investment is said to be ideal for portfolio holdings for retirement accounts because of the low maintenance.
However, the profit turnover of an index fund is generally lower than more risky investment opportunities.
Index funds for cryptocurrencies
At the root of it, index funds for crypto work in the same way as traditional index funds.
Also known as tokenised index funds, index funds for cryptocurrency track the value of Bitcoin and trade on traditional market exchanges rather than exchanges purely focused on cryptocurrency. A crypto index fund allows an investor to invest in Bitcoin without the hassle and trials of active trading or using a cryptocurrency exchange.
How do index funds work?
Because an index fund is a type of mutual fund, the pool of money invested by different investors is used to buy a portfolio of assets that matches the performance of a target index set.
The asset manager adjusts the share of the assets in their portfolio to match that of the index. The result of this is that the return on the fund aligns with the performance of the target index. From there, fund expenses are calculated and the dividends, interest and capital gains are paid out to investors. This happens regularly.
Why invest in index funds?
So why invest in an index fund? Why not just own an asset directly? And with a crypto index fund – why not just Buy Bitcoin directly?
There are several reasons to consider investing in an index fund instead of directly buying assets. For one, the long-term performance of index funds generally outperforms other types of investment in terms of total returns.
Another massive benefit that index funds boast is that they have much lower management fees than other funds. This is because they are passively managed, rather than having the investor undertake any active trading.
Index funds also hold investments until the index itself changes. Since this doesn’t happen very often, there are generally lower transaction costs involved. While in short-term trading, this might not make a major difference, the lower costs can make a massive difference when it comes to overall performance.
These benefits are across the board – both in the traditional markets and for the cryptocurrency space. Investing in cryptocurrency through an index fund means
Hedging against volatility with a tokenised index fund
Hedging against Bitcoin’s reputable volatility can be difficult when directly trading. With an index fund focused on crypto, however, the variety of cryptocurrencies can act as a buffer against the market’s sharp movements.
Since there’s broader exposure to more assets, the investment risks are reduced if the fund is diversified.
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