Index funds create a bundle of related holdings for the purpose of tracking a market index. The funds offer an easier portfolio-building method for long-term investors with relatively low trading costs. Compare funds according to asset amount, holding construction, expense ratio and historical performance. Even rigorous analysis doesn't guarantee profits, however, so consider checking with an investment advisor before choosing a fund.
Broad-index funds try to track the performance of a major index such as the S&P 500 or Dow Jones. Funds that track the entire index have lower risk since the assets spread over a large number of holdings. The Vanguard S&P 500 Index Fund serves as a popular example. Vanguard's fund offers major index tracking with low entry and expense ratio costs. The fund spreads the assets evenly across the holdings to minimize dependence on any one company. Risks still exist, since the S&P 500 favors large cap companies that can lose investor interest at times.
Portioned Broad-Index Funds
Investors also flock to broad-index funds that only track a portion of the larger index. These funds still offer lower risk than a highly specialized fund, but have a narrower focus. SPDR S&P Dividend Exchange-Traded Fund, for example, tracks the S&P High Yield Dividend Aristocrats Index. Aristocrats includes members of the S&P 500 that have increased dividend payments for at least the past 25 years. Using that qualification means that the SPDR fund holds a solid group of companies with well-established histories. The fund also has low entry costs to investors and historically has done well at tracking its index.
Sector Index Funds
Index funds can organize holdings according to sector. The narrow focus of these funds makes for riskier investing but the potential for higher returns. Sector funds work best for investors utilizing a core and satellite holding structure, which places a stable fund such as a broad-index at the center and lesser sector investments on the periphery. Biotechnology stocks have seen a resurgence but a broader healthcare fund helps mitigate some risks of sector-specific investing. Vanguard Health Care Index Fund, for example, mixes biotech, pharmaceutical and insurance companies with a very low historic tracking error and low costs.
Designer Index Funds
Brokers can design funds based on custom-designed specifications. Fund organization can revolve around dividend payments and weigh the holdings according to the dividend payout amount. Brokers essentially invent tracking indexes for these funds to track using the same framework that helped select the holdings. The Vanguard High Dividend Yield Index Fund falls under this category. It has a decent sector spread in the holdings, low entry costs and moderate risk considering dividend-paying companies tend to have better overall health.