What is a stock index? The article points out that even before Modern Portfolio Theory (MPT) took off, indices were already being used as a standard to measure the overall market trends. Little did we know that 50 years later, they would become the most desired investment portfolios for investors? MPT suggests that "every investor should more or less own the entire market." If an investor owns a market-wide portfolio, their expected return should match the risk-free rate, with the entire market growing alongside economic growth.
The logic behind holding index funds (ETFs) is to spread risk across different stocks.
But on the flip side,this means investors give up their ability to judge individual companies, unable to decide on the distribution of industries and companies within the index. This puts investors in a passive position. However, today, index investing doesn’t necessarily mean passive investing. Index funds can also play a hedging role in an overall investment portfolio.