Passive index funds have become popular because of their cost efficiency. But what are index funds, should you invest in them and how can you get started?
Passive index funds have become popular because of their cost efficiency. But what are index funds, should you invest in them and how can you get started?
- Savings and investments
- Personal
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- Index funds
What are index funds?
Index funds are passively managed equity funds that track a certain benchmark index. The funds’ buy and sell transactions are triggered automatically based on developments in the benchmark index.
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How do index funds work?
An index fund will only trade when its benchmark index is updated to reflect the situation in the markets. This might happen two or four times a year, for example. Because of this, an index fund doesn’t require the investor to be very active.
Index funds are also known as passively managed funds because they aim to keep their portfolio allocation as close to their benchmark index as possible, and their portfolio managers don’t have to conduct a market analysis or apply their view of the market.
Passive funds often have lower fees
As a rule, funds that seek returns exceeding the market average through stock and sector picking require more work and analysis than funds that passively track an index. For this reason, index funds often have lower fees than actively managed funds.
The name “passive fund” is slightly misleading, however, as all fund management involves a certain measure of active decision-making. Even an index fund requires its manager to take a view on such aspects as the criteria for tracking the average performance of the market and the actual composition of the index.
In addition to index funds, the name “passive fund” may also refer to exchange-traded funds or ETFs.You can read more about ETFs here.
Pros of passive funds
• Cost efficiency. The management fees of passive funds are usually lower than those of actively managed funds.
• One clear advantage of index funds is that they are well-diversified compared to direct equity investments.
• Investors can influence the asset class and country allocation of their investments. Passive funds are suitable for investors who have the skills, time and interest to manage their personal investments. Unlike active funds, which offer a turnkey solution, passive funds require investors to spend some time on and show interest in managing their investments.
• No portfolio manager risk. The portfolio manager doesn’t influence investment decisions because the fund tracks its benchmark index.
Cons of passive funds
• Index investing requires a certain amount of effort because the investor must choose their preferred funds and update their personal portfolio regularly. In a balanced fund, the investor gets everything in one easy package.
• You can’t outperform the index. With a passive fund, all you can expect is the average market return, also called index return, minus the fund’s fees. This means that your return will always be slightly lower than that of the benchmark index. An active fund, on the other hand, seeks to outperform its benchmark index and provide a higher return than the index.
• Index funds are passive shareholders that don’t punish the managements of companies for making errors, which means the funds’ sustainability rating is not very high. In active funds, however, sustainability aspects are an integral part of risk management to reach the objective of better returns in the long term.
Index funds offered by Nordea
- The selection of index funds we offer includes a fund that invests in global equities (Global Passive Fund), a fund that invests in European equities (European Passive Fund) and a Finnish index fund (Finnish Passive Fund).
- Additionally, we offer Enhance funds, which include global, European, US and emerging market funds. The Enhance funds fall in between active and passive funds – they are affordable and their portfolio manager makes fewer investment decisions than the managers of actively managed funds. The Enhance funds, however, aim to outperform their benchmark index, unlike completely passive funds. Further information on the funds is available in the Funds Now service.
- The funds offered by our digital savings adviser Nora are affordable and represent semi-passive Enhance funds. Nora also offers monthly saving alternatives.
- You can start saving in funds with as little as 10 euros. Simply conclude a fund savings agreement in Netbank or Nordea Mobileand save in funds every month without having to pay subscription or trading fees.
- Monthly saving is an effortless way to grow your savings, while benefitting from the effect of compounding.
- Please note that when you want to buy or sell units in a fund, you will do so at the fund’s net asset value, which is determined once per trading day, based on the official closing price. This means that if you make a trade in the afternoon after the fund’s cut-off time, the trade will be executed at the closing price of the next day. If you sell your units in Nordea funds, you will usually receive the money from the sale in your account after 2–3 days.
How do I start investing in index funds?
All good investment decisions are based on an investment plan.
- Starting to invest in index funds doesn’t differ in any way from starting to invest in any other assets. First, you should prepare an investment plan. This involves thinking about what kind of return you are seeking, how long you plan to stay invested and how much risk you are willing to tolerate.
- Over the long term regular saving each month will provide good time diversification. You can start saving monthly in index funds through Nordea Mobile or Netbank if you have an account with Nordea.
- You can also check your investment profile with Nora, our digital savings adviser, or by booking an appointment with us. The funds offered by our digital savings adviser Nora are affordable and represent semi-passive Enhance funds. Nora also offers monthly saving alternatives.
Important information about investing
The information provided on this website is intended for general product information only and does not constitute investment advice or recommendations. When it comes to funds or equities, past performance is not a guarantee of future results. The value of fund units or equities may increase or decrease due to market movements, and it is not certain that you will get back the entire amount you invested.
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As an investment expert with a deep understanding of passive index funds, let me shed light on the concepts mentioned in the article. My expertise in financial markets and investment strategies allows me to provide valuable insights into the world of index funds.
1. Index Funds:
- Definition: Index funds are passively managed equity funds designed to track a specific benchmark index. The fund's buy and sell transactions are automatically triggered based on changes in the benchmark index.
- How They Work: Index funds trade only when the benchmark index is updated, usually occurring two or four times a year. They aim to keep their portfolio allocation as close to the benchmark index as possible, eliminating the need for constant investor activity.
2. Passive vs. Active Management:
- Passive Management: Index funds are considered passively managed as they seek to replicate the performance of a specific index without active market analysis. This often results in lower fees compared to actively managed funds.
- Active Management: Actively managed funds, in contrast, involve more analysis and decision-making by fund managers to outperform the market.
3. Pros and Cons of Passive Funds:
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Pros:
- Cost Efficiency: Passive funds generally have lower fees than actively managed funds.
- Diversification: Index funds offer broad market exposure, reducing the risk associated with individual stock investments.
- Investor Influence: Investors can influence asset class and country allocation based on their preferences.
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Cons:
- Performance: Passive funds aim to match the market return, so investors cannot outperform the index.
- Sustainability Rating: Passive funds may not actively engage with companies, potentially resulting in a lower sustainability rating.
4. Nordea's Index Funds:
- Nordea offers a range of index funds, including global, European, and Finnish passive funds. They also provide Enhance funds, which fall between active and passive, aiming to outperform their benchmark index.
5. How to Start Investing in Index Funds:
- Starting to invest in index funds involves creating an investment plan that considers return goals, investment duration, and risk tolerance.
- Nordea provides a user-friendly platform, including their digital savings adviser Nora, to help investors start with monthly savings in index funds.
6. Important Information about Investing:
- The article emphasizes the importance of having an investment plan and cautions that past performance is not indicative of future results.
- It also mentions the value fluctuations in fund units or equities due to market movements, highlighting the inherent risks in investing.
In conclusion, index funds, particularly those offered by Nordea, provide a cost-effective and diversified investment option for individuals seeking market exposure without active management. Understanding your investment goals and risk tolerance is crucial when considering index funds as part of your portfolio.
