Index Investing Archives - Exploit Investing

Index funds don't operate like a banks checking or savings account, nor do they operate like a certificate of deposit (CD). They are much more liquid than a CD, but not as simple as a savings account. Exchange traded index funds or ETFs can be sold at any time when the market they operate in is open. You can sell the index fund using your brokerage account. There is no limit to the number transactions, but you can only sell the maximum number of shares you own. Not all index funds are traded as ETFs, some are mutual funds which sell at the price set by the net asset value or NAV calculated at the end of each trading day. While it may be easy enough to sell an index fund, doing so may be the wrong choice for many reasons. I'll dig into the details below, but selling your index fund shares should be avoided if your trying to plan your financial future. What are Index Funds and Why are They So Popular Index funds have exploded in popularity since they simply track the market and many have failed to beat them. They are low cost and a quick and easy way to diversify your portfolio amongst hundreds of stocks. This quickly negates your systemic risk in an one stock. ETF vs Index Funds Index funds should not be confused with ETFs since they are two different things. An ETF can be actively or passively managed. Index funds are the passively managed ETFs that track an index. This can be confusing to many new investors and may get them in trouble if they invest in an ETF that is actively managed like Cathy Woods' Ark Invest. How to Sell an Index Fund (ETF) Easily The steps for selling an index fund are as follows: Log in to your brokerage account. Select the Index fund and how many shares you want to sell. Place a limit sell order, market orders should only be used for high volume funds. Review and confirm order. Wait for order to execute at limit price. Double check whether or not your account is a margin account. You may accidently sell short your index fund if you are not careful. Always double check the amount of shares you actually own as not to sell more than you posses. Advantages of Index Funds over Common Stocks While common stocks especially small caps can provide outsized returns to shareholders if researched properly most individuals don't have the time or patience for them. The ease of use along the below factors offer advantages to the lay investor. Instant diversification: The extreme diversification smooths out the index fund and helps it avoid any major swings from single company events. Transparency: Index funds have far better transparency than mutual funds. Many mutual funds trade in and out of stocks before their investors even know what they own. Minimal research: Far less research needs to be done to find a good fund, vs finding an undervalued stock. Avoiding bias: Trading in and out of stocks can lead to investor bias, owning just one index fund lessons the impact of investor bias. I used to own a few index funds myself, and still do in my employer sponsored retirement account (not my choice). However, I grew bored of my investments and wanted to directly impact them through research and my own decisions. That led me to create this website and delve deep into the world of deep value investing. So lets look at a few reasons you may want to sell an index fund or even hold it forever. When to Sell or Hold an Index Fund There are many times where you may need to sell an index fund, but also a lot of reasons you should hold on to your index funds for as long as possible. Reasons to Hold onto an Index fund Below are some reasons you may want to hold on to your index funds. Give your money time to compound. Selling shares will trigger capital gains taxes. The end of the year funds distribute capital gains as dividends. Not many people realize that the end of the year is when a lot of funds distribute any capital gains to their shareholders. So if you sold a few months earlier you may be missing out on some nice capital gains. How to determine when it's the right time to liquidate If you just invested in a single fund or a few funds that cover the entire market, you may not have much incentive to sell your funds. However, there is a plethora of different funds available and if you want to maximize your returns and minimize your risks you should sell for the following reasons. Rebalancing: If one fund is performing well it may be time to sell some and re-allocated the money to another fund that may have become undervalued. Investment goals change: If you are planning on buying a house like me and my wife it may be time to sell some shares and add it to another asset class, such as a savings account. Change in strategy: You may have decided to invest in more small cap stocks that aren't available in many index funds. Whatever you do, think before you sell your shares. It may be easy to do but it could result in capital losses in a bear market situation. Get a hold of your emotions and think rationally if you will truly need that money sometime soon. How to Avoid Selling an Index Fund The best way to avoid selling an index fund is sticking to a long term investment strategy. Essentially use money you don't need today. In order to do this you should also have at least a 6 month emergency fund saved up. This will let you breathe a bit easier and stress less when the market drops in value, and/or if you unexpectedly lose your job. If your saving up to buy a house there may even be a way to avoid selling shares in an index fund altogether. Using a margin loan you can withdraw money backed by the value of your investments. Just be careful to watch interest rates. As they rise, so does your margin loan rate. It's best used as a stopgap rather than a replacement for a 30 year loan. Mr. Money Mustache explains how he used it effectively on his blog.