I have been talking about the dangers and high costs of investing in typical mutual funds, which is useful to a point, but you may ask “well then, what should I do with my savings?” Of course, this is a question that everyone has to answer for themselves, but one possibility to consider is a strategy called indexing.
An index is a measure of prices among a particular set of stocks. For example, the Dow Jones Industrial Average (DJIA) measures stock prices of 30 of the largest public companies in the U.S. When you hear that “the Dow is up 100 points today,” the commentator is referring to the index of these 30 stocks. Other familiar indexes in the U.S. are the Nasdaq and the S&P 500. In Canada, the main index is the S&P TSX, often abbreviated as the TSX. Each of these indexes is reported as a number that gives us a sense of whether stock prices have gone up or down. If an index goes from 10,000 to 10,100 one day, then stock prices have risen by an average of 1%.
The investment strategy of indexing means owning all the stocks in a particular index. In the case of the S&P 500, this would mean owning shares in each of the 500 large U.S. companies that make up this index. Without some help, the average small investor could not do this. Starting with $50,000, it would be crazy to try to buy an average of $100 worth of 500 different stocks. Fortunately, there are mutual funds available to help with indexing.
The main advantage of indexing is that there are index funds with extremely low Management Expense Ratios (MERs). In the coming posts, I’ll have more to say about indexing including some examples of index funds and how we can go about investing in them.