How to invest in index funds

An index fund is an investment that tracks the market index, usually composed of stocks or bonds. Index funds typically invest in all the components that are included in the index that they track, and have fund managers whose job it is to ensure that the index fund performs as well as it should. That indexes.

Your 3-step process for investing in index funds

Select the index you want to track.

Choose a fund that tracks the index you choose.

Buy shares of this index fund.

1. Choose an index.

There are hundreds of different indexes that you can track using index funds. The most popular index is the S&P 500 Index, which includes the top 500 companies on the US stock market. Here is a short list of some of the additional top indexes, segmented according to what segment of the market they cover:

In addition to these broad indexes, you can find sector indexes linked to specific industries, country indexes targeting stocks in single countries, style indexes for fast-growing companies or Values ​​emphasize stocks, and other indicators that limit their investments. On their own filtering system.

2. Choose the right fund for your index.

Once you have selected the index, you can usually find at least one index fund that tracks it. For popular indexes such as the S&P 500, you may have a dozen or more choices for tracking the same index.

If you have more than one index fund option for your chosen index, you may want to ask some basic questions. First, which index tracks the performance of the fund index more closely? Second, which index fund has the lowest cost? Third, are there any restrictions or restrictions on the index fund that prevent you from investing in it? And finally, do fundraisers have other index funds that you are also interested in using? The answers to these questions should make it easier for you to choose the right index fund.

3. Buy shares of Index Fund.

You can open a brokerage account that allows you to buy and sell shares of the index fund in which you are interested. Alternatively, you can open an account directly with a mutual fund company that usually offers funds.

Again, in deciding which method is best for you to buy shares of your index fund, it pays to look at the costs and features. Some brokers charge their clients an additional fee to purchase shares of the Index Fund, making it cheaper to go directly through the Index Fund Company to open a fund account. Even so, many investors prefer to keep all their investments in one brokerage account. If you expect to invest in several different index funds offered by different fund managers, the brokerage option may be the best way to combine all your investments under one account.

There are several benefits to investing in index funds, such as tax efficiency, portfolio diversification and reasonable risk.

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Why invest in index funds?

Investing in index funds is one of the easiest and most effective ways for investors to build wealth. By simply combining the impressive performance of financial markets over time, index funds can turn your investment into a big nest egg in the long run - and best of all you need to You don't have to be a stock market expert.

Index funds are especially useful to investors for a number of reasons:

Minimize the time spent researching individual stocks. Instead, you can rely on the fund's portfolio manager to invest in an index that already includes the stocks you want to invest in.

You can invest with less risk. Most indexes include dozens or even hundreds of stocks and other investments, and diversity makes you less likely to incur large losses if something bad happens to one or two companies in the index.

Index funds are available for a variety of investments. You can buy stock index funds and bond index funds, which cover two major parts of most people's investment strategies. But you can also buy more focused index funds that drill down in some segments of the financial markets.

It is much less expensive. Index funds are generally far less expensive than alternatively managed funds. This is because an index fund manager only has to buy stocks or other investments in the index - you don't have to pay them to try to pick their own stocks.

You will pay less in taxes. Index funds are quite tax efficient compared to many other investments. For example, index funds do not have to buy and sell their holdings as much as actively managed funds, and therefore index funds avoid creating capital gains that you can.

As simple and easy as index funds are, they are not for everyone. Some of the ups and downs of investing in index funds include:

You will never beat the market. Index funds are only designed to match market performance, so if you want to prove your worth as a top investor, index funds will not give you this opportunity.

You have no loss protection. Index funds track their markets in good and bad times, and when the market sinks, so does your index fund.

You will not always own the stock of your choice. Depending on the index you choose, you may own some stocks that you do not have, while you may lose others of your choice.

To overcome some of these shortcomings, you can always have a mix of index funds and other investments to give you more flexibility. If you plan to use the full range of index funds, however, you need to be comfortable with them. To learn more about your other investment options: How to invest your money.

Other investment options

4 Index funds to get you started

If you are looking for some index fund ideas to help you make a better investment, the following four are a good place to start.

Vanguard 500 Index (NYSEMKT: VOO): Tracks the S&P 500 Index. $ 4 annual cost for an investment of $ 10,000

Vanguard Total Stock Market (NasdaqMutFund: VTSAX): Tracks the US stock index of all sizes; $ 4 annual cost for an investment of $ 10,000

Vanguard Total International Stock Market (NASDAQ: VXUS): Tracks global stock indexes excluding the United States. Cost of $ 11 per annum for an investment of 10,000

Vanguard Total Bond (NasdaqMutFund: VBTLX): Tracks the index of different bonds. $ 5 annual cost for an investment of $ 10,000

Source: Vanguard Group

Vanguard funds are widely considered an easy entry point for new index fund investors, but you can find similar funds from other providers. By combining a wide variety of stocks with a fund focused on bonds, these four funds allow you to invest using asset allocation strategies so that you risk getting the best possible return. Help manage.

Let index funds help you get rich.

Index funds offer investors of every skill level an easy, successful way to invest. If you are interested in raising money but are not passionate about doing a lot of research, then index funds can be a great solution for achieving your financial goals.

Frequently Asked Questions

Index funds are a special type of financial vehicle that collects money from investors and invests it in securities such as stocks or bonds. The purpose of an index fund is to track the profits of a designated stock market index. The market index is a fictitious portfolio of securities representing a segment of the market. For example, the S&P 500 Index represents 500 major US companies.

The average annual return of the S&P 500 is close to 10% in the long run. The performance of the S&P 500 index has been better than others in some years.

Low cost index funds are one of the most useful investment vehicles for those who are focused on the long term. Before investing your hard-earned dollars, it is important to know the proportion of the fund's expenses, which indicates how much you will pay in management fees. Here are some of the top low cost index funds and their expense ratios:

Vanguard S&P 500 ETF 0.03%

Vanguard Large Cap ETF 0.04%

Schwab US Large Cap ETF 0.03%

Vanguard Mid-Cap ETF 0.04%

Schwab US Mid Cap ETF 0.04%

Vanguard Small- Cap ETF 0.05%

iShares Core S&P Small-Cap ETF 0.06%

Schwab US Broad Market 0.03%

iShares Core S&P Total US Stock Market 0.03%

Vanguard Total Stock Market 0.04%

Dan Keplinger holds positions in the Vanguard Total International Stock ETF. Motley Fool has positions in Vanguard S&P 500 ETF and Vanguard Total International Stock ETF and is recommended. Motley Fool has a disclosure policy.