Index mutual friends may be boring, writes Marta Norton for Morningstar, but that doesn’t mean they’re bad. They may be simple, but, unlike actively managed funds, investors don’t have to worry about wayward managers, and they often don’t require as much legwork to find a good one. Norton reminds us not to forget the basics when selecting an index fund.
If all things are equal go with the cheaper fund. “Regardless of their assigned category, index funds should all have the same purpose: Closely mimic an index that captures the characteristics of the market segment that the index fund wishes to track,” Norton says. “Thus, index funds covering the same area should provide the same exposure to the same market forces.”
There may be fees lurking in transaction costs, like brokerage commisisons and market impact costs, that aren’t included in the expense ratio. Watch out for frequently-traded funds. Not only that, but some indexes use a committee to decide which stocks are considered in the index.
Costs aren’t the only thing to consider; it’s one thing to be innovative, but an unusual index methodology may work better in theory than reality. Check out the index construction before selecting a fund. Norton recommends choosing a “broad-based index fund whose success isn’t dependent on the accuracy of your market-timing.”