How Index Funds Work — Like Small Chops!

Have you been wondering what exactly it means to be an index fund investor? We’re going to break down how index fund investing actually works.

Index Fund Investing Vs. Stock Picking

Whenever you think about index fund investing, think about an index as something that is tracking the performance of something else.

Some examples are:

1. The tech industry — what is the overall performance

2. What is the index of the overall best Premier League players out there

An index is just something tracking something.

When you think about investing into an index fund, what you’re really doing is investing into something that’s tracking an overall performance of whatever industry you actually want to invest into.

Picture this, you’re at an Owambe and there are 3 coolers full of small chops.

Imagine cooler 1 tracks companies in the tech industry, cooler 2 is real estate and cooler 3 is healthcare. Whatever cooler you choose to invest in — all you’re literally doing is buying every single company that’s a part of that industry.

So for example, when people say they are invested in the S&P 500 — all that really is is a cooler of the top 500 largest companies and when invest in this cooler, you’re investing into every single one of these companies and getting the average return every year of that overall index. Simple right?!

In comparison, stock pickers think they are actually smarter and will pick individual stocks instead of a selection. But to do this takes a lot of work and you have to go through different companies to find companies that are actually valued at what their price is reflected at in the stock market. Most people don’t actually have the time to analyse companies, what they’re doing is looking for things they like and are eye-catching — eg. Netflix & Tesla, without understanding the whole business and their financials. This is risky if you don’t know what you’re doing!

Let’s break this down for our analogy:

So we’ve got Cooler 1 which tracks tech industry. Inside we have:

Puff Puff — Amazon

Samosa — Facebook

Spring roll — Samsung

BBQ chicken — Apple

Asun — Tesla

An index fund investor will take a variety of small chops (diversification) to reduce the likelihood of one being bad whereas a stock picker will only choose one thing.

For index fund investors, it doesn’t matter if one company fails or your piece of chicken is stale because you still have other things in the cooler to fall back on whereas, if all your chicken is stale and the company you picked fails, you’ll lose everything.

How to Invest in An Index Fund

Wealth8 provides access to global and diversified index fund portfolios managed by global asset managers such as BlackRock. You can choose from a selection of funds based on your risk level and can get started with literally £8! By investing regularly, you’ll see very quickly that you can build up your wealth relatively easily — it just takes a little bit of time and consistency. With investment, your capital is at risk.

This article should not be read as personal financial advice. Individual investors should make their own decisions or seek independent advice.