What are the advantages of indexing?

 

Low expense ratios

Since index investment managers don't actively attempt to outperform a given market by betting on individual stocks and as a result don't need a supporting team of analysts, their management fees are lower than those charged by active managers. Lower management fees result in index investments, such as index funds and index ETFs having much lower expense ratios, on average, than actively managed investments.

 

Tax efficiency

The rate at which securities are bought and sold in index ETFs and mutual funds is significantly lower than the turnover rate in actively managed ETFs and mutual funds. This low turnover tends to generate fewer capital gains.

It's important to remember that the tax efficiency of index funds and ETFs can vary widely, depending on the index being tracked (indexes with fewer securities sometimes generate higher turnover) and the management approach used to track the index. For example, a full replication strategy often results in lower turnover than an optimization strategy.

Learn more about index-tracking approaches

Keep in mind that ETFs can be more tax-efficient than conventional index mutual funds because of their unique in-kind creation/redemption process.

Learn more about the creation/redemption process

 

Risk control

Indexing eliminates the risk that an active manager will select securities that underperform the market. This is especially true with strategies that target broad-market exposure.

 

Diversification

Many ETFs seek to track indexes that hold a broad range of securities, which acts to enhance diversification and dampen the risk associated with holding individual securities and ETFs that invest in narrow market segments.

 

Style consistency

In most cases, an index ETF will closely track its benchmark and provide a high level of style consistency.

All investing is subject to risk, including possible loss of principal.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

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