One of the most popular investment techniques involves investing in and building a portfolio of low-cost Index funds. The rationale behind investing this way has a lot to do with the fact that many investments will use the index as a benchmark against which to measure performance.

For example, if you were to invest in a large-cap fund (either mutual fund or ETF), the manager who overlooks the investments of that fund will be measured in terms of performance. Whether or not that manager's performance for any given year is "good" or "bad" will be based on how well it performs against an actual index, such as the S&P large cap index or the broader S&P 500. (Performance is measured this way because a 10% annualized return might not be so hot if the index returned 25%).

Statistically, an investor virtually has a 50% chance of performing better than the index and a 50% chance of under-performing compared to the index over the long-term. We say virtually because a couple of other factors would be considered, such as whether the index's overall trend is on the rise or is sinking. As well, it is possible, however unlikely, than an investor performs exactly as the index would. So, the investor has a 50% chance of virtually outperforming the index.

Since an investor's success is therefore measured against an index of some sort, why not eliminate at least one element of uncertainty in a portfolio and simply invest in the index itself? Instead of worrying whether or not your investment is a good or bad one, all you would have to do is worry about whether the overall index will perform well for the year, or poorly.

This technique makes a lot of sense for many investors who know what they need in terms of asset allocation (see below) but who also know that since so much is "riding" on the index, it is best to simply purchase the index. The problem, however, is that the index is not always the best place to invest. Investors will sometimes miss out on great investment opportunities that are managed by bright manager by investing in "just" the index. There are plenty examples of this in the investment world.

As for Asset Allocation, as long as the investor knows how much of their investment should go into growth or equity funds and how much should go into income-producing investments (and all of the sub-classes in between), then index funds can certainly work. Without knowing the asset allocation however, it is most likely that a balanced fund will work best.