An index fund is a mutual fund that aims to replicate the performance of a specified market benchmark or index. This is accomplished by buying a representative sample of the securities that make up the index. Unlike a conventional actively managed investment portfolio, indexing is a "passive" investment strategy which emphasises diversification, replication of index returns and low portfolio turnover.

LESS EXPENSES

No attempt is made to outperform the index nor any human judgement is required on whether or not to buy a single stock. As a result, the fees associated with index funds tend to be lower when compared to active funds since they incur lower advisory fees and transaction costs and have no research costs.

• Less Management Fees

In any given year, it is quite often that a large percentage of active funds underperform the markets they set out to beat, especially after fees are subtracted. By definition, the average performance of investors in a certain type of asset is equal to the index of that asset type, before fees. Index funds almost always have lower management fees than active funds, usually by 0.5% to 1% per year. Thus, there is a high chance that an index fund will outperform actively managed investors seeking to beat that index by about the same amount as the difference in fees.

In addition as no attempt is made to outpace the index nor any human judgement is required on whether or not to buy a single stock, index funds can be managed by a small staff. A personal computer can calculate at minimal expense how much to buy or sell of each stock when money flows in or out of an index fund. There is no need to pay a "star" manager with a strong track record to choose winning stocks. As a result, index funds incur minimal advisory fees, distribution charges and other operating expenses. In addition, index funds do not incur any research costs at all.

• Lower Trading Costs

Indexing is a "passive" investment strategy which emphasizes replication of index returns, broad diversification and low portfolio trading activity. Indexing has an inherent cost advantage. Unlike the traditional "active" money management which buys and sells securities regularly in an effort to beat the market, index funds have relatively low trading activity. An index fund manager simply holds a representative sample of the securities in the index. Trading occurs mainly when the composition of the target index changes or in response to share purchases and redemptions. The low portfolio turnover would translate to low transaction costs for the investor.

INDEX OFFERS DIVERSIFICATION

A good investment strategy does not and should not put all eggs in one basket. The next key advantage is the diversification benefits accruing to the index investor. Indexing guarantees that an investor's money will be spread over the entire market as the portfolio normally comprises all stocks in the same percentage as the index. A well-diversified investment portfolio would in turn mean lower risk for the investor.

A GREATER PEACE OF MIND

Indexing also offers investors a high degree of relative predictability - meaning that index funds closely parallel the ups and downs of their respective indexes. No investment strategy can ensure absolute returns, but index investors can feel confident that the fund's performance should mirror that of its target index, minus operating expenses, in the long term. Since operating an index fund involves no decisions on active management, there is little for an investor to supervise. The basic principle behind indexing is that it aims to eliminate the risks, costs and uncertainties of "active" management (stock picking and market timing). It is no wonder that index investors tend to sleep easier at night.

FOR THE LONG-TERM INVESTOR

It is therefore not surprising that numerous independent studies have shown that indexing would provide greater returns over time with less risk and lower costs. Indexing is definitely highly recommended for investors who have a low appetite for risk and little time to stay on top of their investments.

Indexing should not be thought of as a "hot" or short-term investment strategy as its benefits are reaped over the long term. Indexing's main appeal is not to investors who expect to make extra-ordinary gains. Instead, indexing should attract long-term investors who seek a very competitive long-term investment return through broadly diversified portfolios.