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Indices, explained. Crypto, obtained

Indices, explained. Crypto, obtained

Explainers Trading

14 Apr 2020

There are many different trading styles, but at the highest level we can define two overall approaches: active and passive investing.

  • Active investors use their skills and insights to beat the market by picking losers and winners based on their market predictions.
  • Passive investors are more interested in matching overall market returns. Instead of picking individual assets, they divide their funds across different types of investments to simply follow the movements of the market.

Index investing a type of passive investment, where the goal is to generate returns that match a broad market index with a simple buy-and-hold strategy. In traditional markets, investors do this by buying into investment vehicles that closely track the underlying index such as a fixed-income index, index mutual fund or exchange-traded funds.

There are many different advantages to index investing, but perhaps the most fundamental one is that taking a hands-off approach to investing reduces the effects of emotional reactions that investors are often misled by when investing actively.

Famously, the very successful active investor Warren Buffet has said index investing is the best option for most people. Warren Buffet is well-known for his stock picking abilities, but when it comes to long-term investing, his advice is to simply buy and hold index funds. He argues that most people simply don’t have the time and resources to do the necessary research for investing actively, and too often emotional reactions throw investors off their strategies as soon as market conditions turn uncertain.

To illustrate his point, say you invested $10,000 in a low-cost S&P 500 index fund in 1980, and you would have re-invested all dividends accrued over time, the total return after expenses would have net you around $780,000, 40 years later in 2020.

Popular indices in traditional finance

There are many different types of index funds available on the market that track various industries, markets and asset classes. Some of the most popular ones include:

  • The Dow Jones Index tracks the performance of a small selection of companies which are the most widely held and publicly traded companies in the US.
  • The S&P 500 Index includes stocks of 500 of the largest companies in the US, so by buying into this fund you are investing in the US economy as a whole.
  • The MSCI EAFE tracks the performance of stocks in countries outside the US – EAFE stands for Europe, Asia, Far East.
  • The Russel 2000 Index is a fund that tracks the performance of smaller but widely traded companies.
  • The USAA Nasdaq 100 Index Fund tracks the performance of the top 100 biggest non-financial stocks available on the Nasdaq exchange – a platform specialized in tech companies across finance, telecom, retail, biotech and other emerging tech sectors.

The benefits of Index investing

This passive investment strategy is an effective way to manage risks while still achieving consistent and considerable gains over the long run. People that support index investing often take the position that ‘beating’ the market is just about impossible once you take trading and tax costs into account. Since investing in index funds incurs much lower management fees and expense ratios, securing profits is in fact much more realistic. So, what are the benefits of index investing?

1. Index investing is consistent

Of all the investing rules, sticking to your plan is one of the most important things to do as an investor. As market conditions change, people will always be influenced by their emotions and start buying and selling based on these emotions, even though this may lead them to deviate from the original strategy. With index investing, it’s easier to stay consistent because there isn’t that much to adjust or play around with. When you’re in the fund, you’re in it for the long run.

2. Index investing is diversified

Buying into an index funds immediately diversifies your portfolio. As the index fund will consist of a broad basket of assets, it minimizes risk related to just a few specific companies or industries, and instead provides exposure across industries and markets.

3. Index investing is low-cost

Of course, you could go out and buy all the individual stocks yourself and actively diversify your own holdings – but that is both time-consuming as well as expensive. Instead, buying into an index fund means you only have to make one consolidated trade – that’s both quicker and less expensive. The reason why index funds are cheaper to get into, is that the combination of simplicity and absence of a portfolio manager creates very modest fees in general.

Crypto trading Index funds

There are typically 2 different ways you can take the principles of passive investment like index investing and apply it in the world of crypto trading.

Traditional finance offering crypto exposure

Some of the major fund managers in traditional finance have started offering funds for their customers as a way to buy into crypto markets and gain exposure to some of the explosive price movements the market is known for.

These are typically services built for investors who aren’t ready to manage their own cryptocurrencies but would still like some form of exposure. They are actively managed by portfolio managers, and therefore the fees incurred through these funds are typically quite high. Additionally, many of these funds are only available to accredited investors, which means that in the US for example you would need over $1M in net worth.

Index of various crypto assets

Retail investors can still buy into crypto focused indices created by crypto and fintech companies.

Coinbase Bundle allows users to buy into the top 5 cryptocurrencies by market cap, Circle Invest does the same for the top 12 cryptocurrencies, and Abra offers a product which consists of BTC, ETH and XRP.

The FTX exchange has a number if indices which track different sets of crypto assets such as SHIT-PERP which tracks the prices of 58 low market cap coins, and the Dragon Index which tracks 9 of the most popular crypto assets of Chinese origin including ARPA, IOST, NEO and TRON .

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