What are Index Funds? (With Benefits and Applications)

By Indeed Editorial Team

Published 4 May 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

An index fund is a suitable option for investors who want to invest in various classes in the stock market. Index funds measure the performance and availability of stocks and bonds in the stock market. If you're interested in a career in investing, understanding these funds may help you succeed in your role. In this article, we discuss what index funds are, provide steps on how to invest in them, describe the duties of a stockbroker regarding these funds and highlight their skills.

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What are index funds?

Index funds are a portfolio of bonds or funds that mimic the performance and composition of a financial market index. It involves investing in a market index with a range of stocks and bonds across the market. Tracking all components in an index may assist you in narrowing down your options when choosing the one that's right for you or your clients.

The aim of an index fund is to ensure you benefit from a share market increase. This may be possible if you keep a close watch on your index and ensure its performance tallies with the entire index. Several index funds may be available on the market to select from. They may include:

  • Equity: An equity index fund tracks specific stocks. This index fund monitors every major stock on the market.

  • Broad market: A broad market index fund is a mutual fund that comprises investments tracking a broad index. This index fund duplicates the entire investable market performance.

  • Bond: A bond index fund tracks the performance of specific bonds and funds invested in revolving credit and government securities with different specifications. They invest in specified bonds that reflect an index's performance.

  • International: These are index funds invested in other countries. This index fund can track indexes in other countries.

  • Socially responsible mutual funds: This index fund encourages and protects the environment. Social index funds can only invest in companies that operate under this mission.

  • Sector: Sector index funds can invest specifically in industrial sectors, such as health care. Investing in sector funds may help you gain exposure to the wide industry with a single investment.

  • Balanced: This index fund invests securities across asset classes. It also contains elements of stocks and bonds of the portfolio.

  • Dividend: This is an index fund that only invests in stocks paying high dividends. It's suitable if your primary aim is to generate increased income from your investment.

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How to use an index fund

Before committing your client to any index fund investment choice, you may consider researching widely about this investment option. Below are some steps you can follow to help yo use an index fund effectively for your clients:

1. Review client's investment goals

You may examine your client's financial situation and life objectives. Determining when they consider retiring and their budget can give you a clue about their investment goals and objectives. Enlightening them on these factors may help them decide how much they're willing to invest in index funds. Let them decide how much money they are ready to invest. Understanding their investment goals may help you determine the right bond and amount they can invest. The following can be helpful when reviewing the investment goals of your client:

  • evaluating their current income after deducting all taxes

  • determining their total current expenses during that period

  • finding out their debts and how much they pay out every month

  • assessing your client's net worth

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2. Determine the right fund for them

After evaluating your client's investment goal and financial strength, you may consider selecting the corresponding index fund that can best suit their investment plan. To choose the best option, you may determine which index fund tracks the performance of an index more closely and evaluate the index fund that matches your client's investment. Consider identifying any limitations and restrictions that may prevent you from investing in the index fund and discuss them with your client.

3. Pick the index fund

After examining various indexes, you may choose the best one that suits your client's investment plan. You may explain to them why you chose a specific index fund. Companies may have different fees and portfolio structures, so conducting research and understanding the difference within the broad index may be essential. You can consider two significant cost ratios when determining an index fund best for your client:

  • Tax cost ratio: The tax cost ratio, also known as tax efficiency, gets calculated annually. It's based on the tax amount you pay on distribution compared to the returns you get.

  • Expense ratio: This refers to an expense ratio, a fee charged to investors annually to cover administrative expenses. Its inclusive of all the fees required for managing the fund.

4. Purchase index fund securities

After conducting due diligence and choosing the index fund that suits your client's investment objectives, you can decide with the approval of your client to purchase the number of shares agreed upon. The client might decide whether to open an account directly with a Mutual Fund Company or remain with you as their broker. They can then start buying and selling shares through a brokerage account if they opt to remain with you.

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5. Manage the investments

After successfully investing your client's finances in an index fund, you can:

  • Continue investing regularly: Encourage the client to set up automatic monthly contributions depending on their investment goals. They can also schedule when to add more money to increase their portfolio sizes.

  • Check-in regularly with the investments: Index funds sometimes rebalance on their own, schedule checks on their investments either yearly or quarterly to confirm if it's valuable. Therefore, checking on them time after time may help you make timely adjustments on their behalf.

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Stockbroker responsibilities in index fund investments

As an index fund stockbroker, your responsibilities may include the following:

  • Advising clients: As a stockbroker, you may provide accurate investment advice to your clients. You can conduct research about the index fund before recommending that your client invests in them.

  • Reporting evaluation: Client financial evaluation forms a concrete basis for determining index fund investment choices. An accurate assessment of these reports may lead to better investment decisions.

  • Sourcing new clients: As an index fund stockbroker, you can continuously on-board new clients into your firm. You can achieve this by cold calling and networking.

  • Managing client's portfolios: You can monitor your client's index fund investment portfolio. Always assess the portfolio and inform them whether it's the right time to buy more or sell the shares.

  • Strategising investment plans: You may strategise proper investment plans to ensure your clients benefit from their massive investments. You can also assess prevailing market conditions and inform your clients.

  • Updating clients: You can provide updates about the client's investment portfolios. Clients can use this information to increase or reduce their portfolio size.

Skills for a stockbroker

As an agent in an index fund, you might require the following skills:

  • Ability to persuade: These skills can help your clients to agree with your opinion or idea. Stockbrokers may continue sourcing new clients for their brokerage firms if they possess these skills.

  • Communication: As an index fund broker, communication is vital, because you may report to the client every time there is progress or an adjustment in their portfolio. This may require you to have both verbal and non-verbal skills.

  • Decision-making: This refers to how proficient you are in making choices when faced with two or more alternatives. Determining the right index fund for your clients involves using strong decision-making skills.

  • Numeracy: Index funds comprise figures and numbers and this requires numeracy skills. These skills can help you apply mathematical concepts in evaluating investment reviews, your client's portfolio size, tax and projection of share prices in the future.

  • Negotiation: These inherent qualities may help you bargain for an item and buy it at a reasonable price. Negotiation skills might be essential when representing your client on the stock market.

  • Ability to cement relationships: Better relationships can maintain connections between two or more people for a long time. Brokers with this skill always have more clients in their camps who are unwilling to leave after onboarding.

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