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Finance Glossary

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Index Funds - Why Buy?

Definition:

Myth: People don't get rich in index funds but they don't usually go broke Truth: They do get rich and they do go broke. As with everything, it depends on how long you hold and when you have to sell. The secret to getting rich is often compounding and as well as NOT doing stupid things. If you have a reasonably long time horizon and you don't over-leverage yourself so that if things decline, your bank won't call and take all your money away, you can get very wealthy on index funds. Each year, your index fund on average grows 8%. If you reinvest that money, you can double roughly every 9 years.

Index funds tend to be more volatile than mutual funds, mainly because they do not hold cash. A typical mutual fund during any rocky climate will hold between 3 and 10% cash. In down markets this cushions the downside (and funds have to hold cash because every day people fire them and people hire them as money gets wired in and out and they need the buffer and on many days when cash is wired in, the fund managers can't find anything to buy selling at prices they like). But over time, markets go up - so holding cash is a drag on performance.

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