Planning & Education | Index Funds

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Index Funds

Equity index funds — which are passively managed and may have low portfolio turnover rates — may provide you with several advantages over actively managed equity funds.

Tax advantage: Since equity index funds are designed to mirror the portfolio composition of a stock index, their portfolio turnover rates are generally determined by which securities are in the index and how they're weighted, not by the investment strategies of any particular portfolio manager.¹ Some indexes have very low portfolio turnover rates, which potentially can translate into smaller capital gain distributions compared with actively managed funds.² The S&P 500 Stock Index is an example of an index that has historically had a low turnover rate.

Diversification advantage: Many indexes include hundreds or even thousands of stocks, so investing in an index fund may mean you're less susceptible to the ups and downs of a single security.

Cost advantage: Passive management requires less research and trading than active management, so an index fund's underlying management fees are generally lower than an actively managed funds.³

Strategy advantage: Investing in an index fund means you usually have a good idea about which securities are held by your fund. In fact, this is usually defined right in the prospectus by the fund's target correlation. For example, an index fund might seek a correlation between its performance and that of the index of at least 0.95 (before expenses). A correlation of 1.00 would mean that the index fund and the index were exactly correlated.

Next: Tax-Exempt Funds

1. Portfolio turnover rates are subject to change and do not, by themselves, automatically result in high or low distribution levels. There can be no guarantee that any fund will generate any specific level of distributions annually or achieve any level of tax efficiency. Investment return and principal value will fluctuate and investors will receive more or less than original cost upon redemption, which means you could lose money. Tax consequences are only one of many factors you must consider when determining when to buy and/or sell equity fund shares.

2. Additional gains may be realized if the portfolio manager must liquidate securities to raise cash for shareholder redemptions.

3. Other factors influence overall costs, including annual expenses and other charges.

This information is general in nature and is not intended to constitute tax advice. Please consult your tax advisor for more detailed information on tax issues and for advice on your specific situation.

Investors should consider the investment objectives, risks, charges, and expenses of a fund carefully before investing. Download a prospectus that contains this and other information about a fund, and read it carefully before investing.