How to Invest Based on Stock Market Indexes - dummies

How to Invest Based on Stock Market Indexes

With investments based on indexes, you can invest in the general market or a particular industry. Say that you want to invest in the Dow Jones Industrial Average (DJIA). After all, why try to “beat the market” if just matching it is sufficient to grow your wealth?

Why not have a portfolio that directly mirrors the DJIA? Well, it’s too impractical and expensive to invest in all 30 stocks that are in the DJIA. Fortunately, there are alternatives that can accomplish the act of “investing in indexes.” Here are a couple of the better ways:

  • Index mutual funds: An index mutual fund is much like a regular mutual fund except that it will only invest in securities (in this case, stocks) that match as closely as possible the basket of stocks that are in that particular index. There are index mutual funds, for example, that track the DJIA and the Standard & Poor’s 500.

  • Exchange Traded Funds (ETFs): ETFs have similar characteristics to a mutual fund except for a few key differences. An ETF can reflect a basket of stocks that mirror a particular index, but the ETF can be traded like a stock itself.

    You can transact ETFs like stocks in that you can buy, sell, or go short. You can put stop losses on them and you can even purchase them on margin. ETFs can give you the diversification of mutual funds coupled with the versatility of stocks. Examples of ETFs that track indexes are the DJIA ETF (symbol DIA) and the ETF for Nasdaq (QQQ).