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Sunday, August 15, 2010

Advantages & Disadvantages of Buying an Index

Advantages of Buying an Index

Indexes are a nice way to gain exposure to certain markets or sectors without having to corner the market in stocks. It’s easier to buy a commodity index instead of buying barrels of oil, some cattle, and a few bags of wheat. You can gain exposure to the overall performance of a market buy buying the appropriate index basket.

Disadvantages of Buying an Index

While an index is designed to emulate a certain market, it doesn’t mean it’s 100% accurate. Just because you buy a foreign market index in a certain region doesn’t mean your basket will move exactly with the economy of that region. There are many factors that can alter the course of a market that sometimes an index can’t reflect, at least not immediately.

Filling a basket order is not always the easiest process either. While it is easier to buy an index than 4,000 industry stocks, that doesn’t mean you always get your target price. If you use market orders, you will eventually fill your basket, but you may not get the desired price. Or if you use limit orders, you may not get all the shares needed to fill the basket.

And not all indexes are liquid. Meaning it may be difficult to trade in and out of certain index positions. Then again, the same thing can be said for certain securities as well.