How to Invest in Index Funds
An index fund can be described as a kind of mutual fund with holdings that track or match a certain market index. You can have a diversified portfolio and earn significant returns with this kind of investment. The reason is that index funds are not in competition with the market; they are, instead, trying to be the market.
That is, buying stocks of all the listed firms on the index and therefore reflecting the index’s performance. Index funds are helpful in balancing the risk in the portfolio of an investor. Market swings are usually less volatile throughout the index unlike with individual stocks. They allow you to buy the entire market indirectly.
With an index fund, you buy the securities making up the entire index. An index fund usually buys shares from all companies that are listed on an index. An investor then buys shares from that fund and its value will reflect the losses and gains of the index that is being tracked. You win by accepting defeat.
There is a high likelihood that you will not outperform the market when you pick individual stocks. Even experienced investors do not. According to research (2001 to 2016), over 90 percent of active fund managers actually underperformed their benchmark index. You have a better chance of meeting market gains than you have of beating the market. That is the major purpose of index funds.
Index funds are becoming more popular among investors. Actively managed exchange-traded funds and mutual funds saw outflows of almost $514 billion. Passively managed funds, on the other hand, saw about $1.6 trillion in new money (April 2014 to April 2017). The increased popularity of passive investing and robo-advisors are responsible for this. There are index funds across different asset classes. An investor can acquire funds that focus on a specific sector such as technology or on companies with large, medium, or small capital values.
These indexes may not be as diversified as the broadest index market, but they are still diversified. What is in It for You? Although individual stocks rise and fall, indexes rise with time. You may not get an insane profit during a bear market with index funds, but you will also not lose your money in one investment. With index funds, there are fewer fees that reduce your returns. For index funds the expense ratios (cost of management and commissions of your account) are lower. This is because they are easier to run than the managed accounts.
You will not be paying someone to assess financial statements. You diversify your portfolio with index funds. Index funds, just like other mutual funds, spread risk and offer investors more choice among riskier and conservative investments and also a wider mix of asset classes and industries. It is easy to understand index funds. It may be a little difficult to understand most investing strategies. However, what you see with index funds is exactly what you get.
Index mutual funds are an easy, affordable, and diversified option of investing in the stock market. When you buy an index fund as an investor, you get a variety of stocks in a single package—without having to go through the trouble of buying each one individually. The management fee is fairly low because the funds contain all investments in a specific index. You, therefore, end up getting higher investment returns.
Buying an Index Fund
- Choose Where to Buy
You can buy an index fund from a brokerage or a mutual fund company. The same applies for ETFs (exchange-traded funds).
When deciding where to buy, consider the following:
Fund selection: do you prefer to buy index funds from different fund families? Major mutual fund companies hold their competitor’s funds. However, the selection is likely to be limited compared to what you will get from a discount broker’s line up. Convenience: look for a single provider who will cater for all your needs.
For instance, if you are only interested in mutual funds, a mutual fund company will do just fine as your investment hub. However, for screening tools and sophisticated stock research, you may need to go to a discount broker. Commission-free options: see if they offer commission-free ETFs or mutual funds with no transaction fee. Trading costs: check how much a fund company or broker charges to sell and buy the index fund if there is no waiver for the transaction fee or commission.
- Pick an Index
Index mutual funds usually track various indexes. One of the most popular indexes is the Standard and Poor’s 500 index. It tracks some of the largest and well-known businesses in the U.S and represents a wide range of industries. There are other indexes, like the S&P 500, made of other assets such as stocks chosen based on:
- Company size and capitalization
- Geography
- Business industry or sector
- Asset type
- Market opportunities
Despite the wide range of options available, you will probably need to invest in one only.
- Check Investment Minimum
Index funds are known for their low costs. Since they are automated, they do not require a lot of money to run. However, they still have administrative costs which are deducted from each shareholder’s profit. Two funds with a similar investment goal may have varying management costs. The fractions may not seem significant but in the long-run, they can take a huge cut off your returns.
These are the costs you should consider: Investment minimum: this is the minimum amount that is required to invest in an index fund. Account minimum: this should not be confused with the investment minimum. Expense ratio: this cost is deducted from each shareholder’s profit. Tax-cost ratio: these are also, in most cases, deducted from the investment returns.
Other Factors
Is the index fund serving its purpose? It should reflect the progress of the underlying index. Can you afford the index fund you want? You can buy just a piece of the fund if it is too expensive. Would it be better to buy stocks? Are you making progress? There are calculators online that you can use to track your progress.
