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Save $1,583 a year by using index funds instead of active trading | Dollar Saver tip #60

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Save: $1,583 per year

Tip overview: Invest in an index fund instead of actively trading stocks and you not only save on time and fees, you could be earning a lot more in returns each year too.

The standard advice for stock market investors is to hold a diversified portfolio of at least 20-25 stocks.

But for many investors, trying to decide which stocks to invest in, when to buy and when to sell can actually do more damage than good – especially when the market is volatile.

This is where index funds can give you more bang for your buck.

When you invest in an index fund, you're buying a whole portfolio of (typically) major companies that make up the stock market. Emotions are taken out of the equation because the stocks are selected for you and the fees are lower because you only need to make one transaction rather than multiple buy and sell orders for each stock.

Did you know?

The average Australian investor has a share portfolio size of $73,895, according to Finder research.

The reality is when it comes to stock picking, even the experts get it wrong.

In a recent Finder study comparing index fund performance with actively managed portfolios, index funds actually beat stock pickers (active fund managers) over the last 5 years.

On average, index funds delivered returns of 6.79% p.a while actively managed funds (the stock pickers) returned just 5.09% p.a.

This might not seem like a lot, but it adds up in the long run.

Let's say you invested the average share portfolio size of $73,895 into an average index fund 5 years ago. Without adding any more funds, today your portfolio would have grown to $102,629 with earnings of $28,734.

Meanwhile the average actively managed fund returning 5.09% p.a. would have only grown to $94,716.

That's a difference of $7,913… or $1,583 per year after 5 years.

While past performance is no guarantee of future results, the data proves just how difficult it is to beat the market through active trading - even for fund managers with a wealth of experience and tools at their disposal.

So unless you know something even the top stock pickers don't, index funds can make a lot of sense.

Looking for a low-cost online broker to invest in the stock market? Compare share trading platforms to start investing in stocks and ETFs.

Disclaimer: This information should not be interpreted as an endorsement of futures, stocks, ETFs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involve substantial risk of loss and therefore are not appropriate for all investors. Past performance is not an indication of future results. Consider your own circumstances and obtain your own advice before making any trades.

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