Question

Choose ONE strength of index funds and build a compelling argument around it.

Suggested themes (entire argument should revolve around ONE theme only):

1. Index funds are less costly than active funds

2. Index funds offer superior diversification benefits

3. Most active funds fail to outperform index funds

Answer 1

Index funds offer superior diversification benefits as they are the best diversified portfolio of stocks available in the economy.

An index funds is a complete replica of a stock market index. A stock market index is a representative portfolio of best companies present in the economy. An index fund copies stocks in same proportion as it is present in the stock market index. So, it is highly diversified as it is a representative portfolio of best companies in different sectors of an economy.

Stock market index is continuously updated according to performance of different companies. The companies which starts to show downward traction for a longer time frame and start to shrink in overall Market size are excluded out of index , and the companies which start to gain the market share and start to lead an industry are included in the index so there is relative outperformance and high relative diversification. The index fund is passive Investment strategy and it copies stocks in same proportion so it has same diversification and similar rate of return to that of index .

So it can be said that index fund offer superior diversification benefits.