Index funds offer an easy, low-cost way of investing in the financial market. They are comprised of assets that replicate the performance of a given index, such as the S&P 500. These assets might be the best addition to a retirement fund or a low-risk portfolio, especially when you want to keep your costs down. Also, index funds are less volatile compared to numerous other financial assets. To help you understand how to buy index funds, we’ve put together a comprehensive guide introducing you to everything you should know about these smart investments.
Table of Contents
Start Trading in 3 easy steps
1. Open a Free Account
You can buy index funds via a brokerage platform. When selecting the best broker to open a free account, you should consider trading costs and the breadth of fund selection. You can opt for an online broker of your choosing or select one of our recommended ones. Access the main page and click to open a new free account. You need to provide your personal information and a valid ID to comply with KYC regulations.
2. Choose Your Index Funds
Index funds track many indices, including S&P 500, Russell 2000, and Nasdaq Composite. You should pick the index that suits your trading strategy and risk and reward expectations. You can also filter indices according to asset type, geography, company size and capitalisation, and many more. Mutual funds vary in terms of management, costs, and other factors, although they might track the same index.
3. Place a Trade
You need to deposit your money into your new trading account. There are many deposit options, including credit/debit cards, bank/wire transfers, e-wallets, and local transfers. Some mutual funds may have an investment minimum required that can even reach several thousands of dollars in some cases. Keep in mind that mutual funds trade only once per day, typically right after the market closes. If you choose an exchange-traded fund (ETFs), you can trade it during business hours.
What Are Index Funds?
Index funds are mutual funds or exchange-traded funds that track the numerous indices available. They are an important diversification tool as you invest your cash in a basket of different securities. Index funds track the performance and even the companies of a given market index.
An index fund is essentially a portfolio that contains various stocks, bonds, or other assets, so you can easily enhance your market exposure. Index funds are passively managed, which means that they have lower costs than other assets, such as exchange-traded funds. These funds are often recommended for retirement accounts due to the low risk associated with them.
How Do Index Funds Work?
Index funds are an excellent option for those looking for a long-term investment. As they track a market index, they tend to have the same performance as the underlying index. Risks are minimised because index funds track the entire market, so you are not exposed to the high risk associated with individual stocks.
Fund managers create a basket of stocks that replicate a given index. As the index composition changes over time, the fund manager adds or removes companies at the same time. These are the only changes made to index mutual funds over time, so they are considered passive investment instruments. Alternatively, active investing requires the manager to analyse the market and select the top performers.
Many funds track the same index. However, they might have very different management styles and cost structures. Ensure you are familiar with the fund’s characteristics and style before adding it to your portfolio.
Types of Index Funds
There are many types of index funds as they track all types of markets and sectors. Some of the main ones are:
- Broad market index funds are the most varied type that aims to mirror a large portion of the entire investable market, such as Vanguard Total Bond Market Index Fund, or the Vanguard Total Stock Market Index Fund
- Index funds categorised by earnings, such as Vanguard Growth Index Fund
- International index funds provide exposure to foreign markets, such as the Vanguard FTSE All-World ex-US Index Fund
- Index funds based on market capitalisation, such as iShares Morningstar Small-Cap, or the Fidelity Mid Cap Index Fund
- Dividend-focused index funds, such as Vanguard High Dividend Yield Index Fund
- Sector-based index funds, including real estate, utilities, cloud computing, and many more
Should You Invest in Index Funds?
Investors choose to invest in index funds for many reasons. One of the main ones is that you do not need to spend time researching stocks and investing in them individually. Instead, you choose an index fund that includes the companies you want to add to your portfolio.
As index funds can contain even hundreds of investments, your portfolio is highly diversified. In turn, this means lower risk since your capital won’t be significantly affected if one or two of these assets decrease in value.
Finally, you should opt for index funds if you are seeking tax efficiency. These instruments come with lower taxes since there is no active management involved that could bulk up your tax bill.
Pros and Cons of Investing in Index Funds
Where to Start Trading Index Funds?
There are typically two ways in which you can start trading index funds. One is investing directly with a fund provider, and the other is through a brokerage. Generally, investment opportunities are better with a broker. One of the main reasons is that you can choose from various index funds, and you also have access to other assets. If you want to start trading index funds, you can check our curated list of the best online brokers.
Expert Tip for Buying Index Funds“ There are many index funds on the market. Generally, those that track lesser-known indices are more affordable. For instance, an index that contains “S&P 500” in its name has to pay a licensing fee, which means that the expenses are passed down to investors. There are plenty of other indices similar to popular ones without the added cost. ”- Shams Ul Zoha
Things to Consider When Buying Index Funds
Before buying index funds, you need to consider your investment approach and expectations. For instance, if you want stability and low risk, you may want to choose a bond index fund. However, these offer lower rewards, so stock index funds are suitable for long-term growth.
Additionally, you should pick the right index for your portfolio. Whether it is a popular one, such as the S&P 500, or a lesser-known one, the fund’s performance is only as good as the market’s.
Top Index Funds to Invest in Right Now
The best feature of an index fund is that it comes with a bundle of investments. Based on performance, management quality, and cost structure, these are the top index funds to invest in right now.
Fidelity Zero Large Cap Index (FNILX)
The Fidelity Zero Large Cap Index is ideal for cost-efficient portfolios. It tracks the Fidelity US Large Cap Index, and this is extremely similar to the S&P 500. Adding this Fidelity fund to your portfolio comes with no costs as the expense ratio is 0%. In other words, you can invest your capital at no cost.
Vanguard Growth Index Fund (VUG)
This index tracks the CRSP US Large Cap Growth Index, which is similar to the S&P 500 Growth Index. As the name suggests, it contains large-cap growth stocks, so it is a great addition to a long-term investment portfolio. Almost half of its assets are tech stocks and it comes with a small expense ratio of 0.04%. In other words, you need to pay $4 per year for every $10,000 invested. The fund’s average annual return from 2015 to 2020 was 20.34%.
Vanguard Real Estate Index Fund (VNQ)
If you want to diversify your portfolio by investing in real estate, this Vanguard fund is the largest one available today, reaching $33.7 billion in assets. It tracks the MSCI US Investable Market Real Estate 25/50 Index, so your investment grows in tandem with the US real estate market. Its composition is mainly equity REITs. The fund’s 12-month dividend yield as of February 2021 was 3.8%.
Buying Index Funds Summary
Index funds are a good choice for passive and low-risk investors. The overall returns on your investment may not exceed the market, but your risk will also remain low. These instruments are investor-friendly, and so are the platforms that offer these assets.
When it comes to buying index funds, investors should keep in mind that due diligence remains important. Although you will cut down the time spent researching suitable assets, index funds are often overvalued. Make sure you conduct your own research before investing in any financial asset.
Frequently Asked Questions
Index funds are excellent investment opportunities for beginners. They come with lower risk compared to other volatile assets, such as cryptocurrency, but the rewards may also be limited.
Typically, each index fund comes with an initial minimum investment that ranges from $3,000 to $10,000. Then, you need to pay annual costs to cover fund management. This is known as the expense ratio.
This depends on whether the index fund is a mutual fund or an ETF. ETFs trade during regular hours, just like stocks. However, mutual stocks can be traded only once per day when the stock markets close.
Not every broker may provide index funds. You need to check if your chosen platform offers these assets or pick one of our recommended brokers.
Index funds are generally considered safe investments. However, your capital is still at risk. Although the index is much less volatile than any given single stock, your portfolio’s value follows the ups and downs of the market.
There is no recommended moment to invest in index funds. If you want to buy and sell index funds at a profit, you need to identify when the market is low and sell when the price increases. However, if you want to grow your investment over many years, these small fluctuations might turn out to be irrelevant.