A:

There are few certainties in the financial world, but we can say that there is almost zero chance that any index fund could ever lose all of its value.

There are a few reasons for this. First of all, virtually all index funds operate with a very high level of diversification. Most index funds attempt to mirror some large basket or index of stocks, such as the S&P 500, by simply buying and holding identical weights of each stock as the index itself. Thus, because an index fund's holdings are almost always extremely well diversified, it is virtually impossible that all of these holdings' market prices would fall to zero, destroying the value of the entire index. (See also: Introduction To Diversification and The Importance of Diversification.)

Think about it this way: If you randomly pick 100 companies, the odds that a single company of the 100 will go bankrupt might be quite high. However, the odds that each and every one of the 100 companies will go bankrupt and leave shareholders with zero equity is essentially nil. Thus, an investment in a typical index fund has an extremely low chance of resulting in anything close to a 100% loss.

Banking on Book Value

Furthermore, the overall stock market, which most index funds tend to represent with their holdings (or at least a portion or particular sector of the overall market), is almost certain to be producing tangible value over the long term. Because of this, the total book value of all the underlying stocks in an index is expected to go up over the long term. This ensures that any well-diversified index fund will not significantly decline in value over the long term.

Index funds tend to be attractive investments for a well balanced portfolio. In addition to diversification and broad exposure, these funds have low expense ratios, making them inexpensive to own compared to other types of investments. The wide variety of index funds means that you can dip your toe into a number of different industries, sectors and stock classes without doing the legwork of due diligence on individual stocks. 

For novice investors, long-term investors, and those who don't want to spend too much time managing the portfolio, index funds offer a relatively low-risk way to invest and gain exposure to a wide range of equities. (See also: Index Investing and Being Lazy With A Couch Potato Portfolio.)

RELATED FAQS
  1. Is it possible to invest in an index?

    While you cannot buy indexes, which are just benchmarks, there are three ways for you to mirror their performance. Read Answer >>
  2. What are the disadvantages of an index fund over an actively managed fund?

    Read the advantages an actively managed fund has over its more staid compatriot, the indexed fund, and make your own decision ... Read Answer >>
Related Articles
  1. Financial Advisor

    The 4 Best U.S. Equity Index Mutual Funds

    Find out which four index mutual funds are among the best U.S. equities index mutual funds for core holdings in your investment portfolio.
  2. Investing

    3 Index Funds with the Lowest Expense Ratios

    Read detailed information about index mutual funds with some of the lowest expense ratios in their categories, and learn about their pros and cons.
  3. Investing

    Fund Management Issues

    The quality of management is a key component of a fund's success.
  4. Investing

    Retired? Don't Be in Broad-Based Index Funds

    When it comes time to divest, you need to be able to sell high, not low, but broad-based index funds won’t let you do this. There is a solution.
  5. Investing

    Why Index Fund Investing Works

    Over time, index fund investing gained traction and ultimately reshaped the industry. Today, these once obscure funds comprise more than 22 percent of equity mutual fund assets, according to ...
  6. Financial Advisor

    What Are Four Best State Street Funds?

    Discover analyses of the four best State Street Funds that could be allocated to provide diversification to a retirement portfolio.
  7. Investing

    4 Traits Of A Great Index Fund

    If you're planning to fill your portfolio with index funds, here's what you should look for in a high-quality fund.
  8. Investing

    Vanguard Equity Index Funds Overview (VFINX, VTSAX)

    Learn about Vanguard's investment philosophy and its equity index mutual fund offerings, which encompass substantially all equity fund sectors.
  9. Trading

    Using index futures to predict the future

    Want to know whether the stock market will open up or down? Learn about index futures and how they can help predict how the market will trade.
RELATED TERMS
  1. Index Fund

    An index fund is a portfolio of stocks or bonds that is designed ...
  2. Indexing

    In the financial markets, indexing can be used as a statistical ...
  3. Index Investing

    Index investing is a passive strategy that attempts to track ...
  4. Active Index Fund

    Active index funds track an index fund with an additional layer ...
  5. Value Fund

    A value fund is a fund that follows a value investing strategy ...
  6. Equity Fund

    An equity fund is a type of fund that uses investors' capital ...
Hot Definitions
  1. Working Capital

    Working capital, also known as net working capital is a measure of a company's liquidity and operational efficiency.
  2. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  3. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  4. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  5. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
  6. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
Trading Center