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A Good Investment Does Not, Mean a Safe Investment

A few people mentioned to me recently that they thought index funds were a safe investment. Index funds can be a good investment option. But many index funds can experience varying degrees of volatility and all are subject to losses at one level or another. Safety is not inherently a characteristic of index funds.

In general, an index fund is one that invests in a basket of securities to mirror the underlying returns of a specific index. Stock market index funds offer an incredible variety of investment approaches -- from broad-based funds that seek to capture exposure to a wide swath of the market to those with a narrow focus on a particular niche within the investment universe. The most well-known index fund is based on the S&P 500.

The virtues of an index fund do not necessarily include safety. When the S&P 500 Index lost 37% in 2008, funds tracking the index suffered a similar decline as well. Such a loss is not a bad thing if you had the time to hold on until the market recovered, as eventually happened. The problem arose if you needed to access your money when stocks were still down, thereby locking in a loss. An index fund tied to stocks fails to meet the safety test in short time horizons.

Index funds are just a vehicle for investing. As always, it is important to look under the hood to see exactly what you are getting before you proceed. You also need to determine if the investment is geared to help you meet your financial goals.