How to Invest in Index Funds: Do It Right

Daniel Penzing
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Index funds have gained popularity in recent years due to their simplicity and accessibility. Basically, what an index fund does is purchase shares of companies based on a given index. Index funds are popular investment choices because they make it easy for investors to diversify and invest in many companies with a limited upfront investment.

Most index funds track a particular index, meaning that the types of stocks that they hold are set by that index. Index funds may track major indexes like the S&P 500, or they may track smaller industry-specific indexes that are closely tied to the company’s holdings.

Although it may seem simple, index fund investing is not as easy as it may seem. Investing in an index fund is not the same as buying individual stocks, and it requires much more research and analysis. To help you get started, check out our guide to index funds below.

How to Invest in Index Funds

Do It Right

Index funds are some of the most common investments. They are designed to keep up with the market. When you invest in an index fund, you are essentially investing in all or the bulk of the stocks in a fund. In simpler words, you’re betting on a diverse portfolio of companies instead of a particular company or portfolio of companies.

To invest in index, all you need is a brokerage account, a few minutes of your time, and a dollar value that you want to invest. In case you are considering an index fund for your investment, here is how you need to go about the process:

Decide on an investment amount

When it comes to investing in an index fund, you do not need to put in a lot of money. In fact, investing small and regularly is a great way to build wealth since it reduces the amount of time you need to invest. Decide on the amount you would like to invest.

Consider the Investment Options on Offer

There are hundreds of options to choose from when investing in index funds. Some of the popular options include the S&P 500 ETF, S&P 500 mutual fund, Nasdaq-100 ETF, Nasdaq-100 mutual fund, low-cost index funds, and others. Evaluate your options and choose one.

What Is an Index Fund?

An index fund typically follows the performance of a major market index, such as the S&P 500 or the NASDAQ 100. Most index funds are made up of several hundred stocks, but not all funds have to have such a large variety of stocks. An index fund basically buys and sells shares of the companies that are part of the index.

The main advantage of an index fund is that you don’t have to do all the research; you only have to follow the index. It’s a passive approach where you simply track the success of the segment. If the segment is doing well, you’re doing well.

An index fund is a low-cost way to invest, and it generally carries a small amount of risk. Since most index funds buy and sell on the stock market, you could potentially lose a substantial amount of money depending on the market and how the index fund is managed. It’s also important to remember that index funds are not necessarily safer than individual stocks. An index fund that follows the S&P 500, for example, can still do quite poorly if the market crashes. The gains from the index fund are directly related to the gains of the market.

Step #1: Pick a Brokerage and Open an Account

The first step in learning how to invest in index funds is to open an account at a brokerage.

If you already have an account, make sure it’s with a reputable brokerage. You will want to look into things like the number of trades, the account minimum, the fees, and whether you can do your own research. If you are not yet sure to join a full-service brokerage or an online discount brokerage, we have a handy guide to help you pick the right type for your needs.

If you are just getting started in investing, you will probably need to open an account at a full-service brokerage.

It’s unlikely you will have enough to be able to open an account with an online discount brokerage. As you get more experience and are able to manage multiple accounts, fees, and taxes, though, you may very well want to go with a discount broker.

It is also possible, of course, that you will need a full-service brokerage to get started. If you don’t yet know what you need, though, or you are just starting out on your investing journey, you definitely want to get a brokerage account.

Can you buy index funds with a robo-advisor?

A robo-advisor is an online investment management company which offers a service modeled from established global financial advisory firms, such as Charles Schwab, TD Ameritrade, and Vanguard.

The robo-advisor system uses a proprietary software platform to automate the investment management process and makes recommendations for investment.

There are no fees for the software, but you’ll pay underlying costs of investments that are managed, including asset management fees, trading commissions, and sales charges.

Will robo-advisor manage your index funds for you?

Understanding Index Funds

You may have heard about the power of index funds but unsure about how they work. An index fund is a mutual fund that is closely linked to the components of an index.

It’s a tool for investors who want to track a particular market with low costs and low risks.

Some people confuse index funds with exchange-traded funds (ETFs). The two instrument names are used interchangeably but unlike index funds, ETFs are collective investments that are bought and sold on exchanges. So there are important differences between index funds and ETFs, especially within investment management.

Benefits of Index Funds:

Step #2: Pick your first index fund

If you’re new to investing and are wondering how you can get started, the main thing is to make sure that you start somewhere. At first, you might not need to invest heavily, so you can pick a fund that has a low expense ratio. It doesn’t make a lot of sense to choose an extremely small fund either, because the logistics of moving the money around will cost you more money than you’re actually saving.

So when it comes to picking your first index fund, go for something in the middle.

It’s a good idea to look at tried-and-true options, such as Vanguard 500 Index Fund (VFINX), which has a very low annual expense ratio of 0.16%. This has a few advantages:

  • The expense ratio is low, so your portfolio can grow quickly
  • There’s a lot of diversification built into the fund
  • The fund has performed well over the years
  • It’s very stable, so it’s not likely to have huge fluctuations in value (which can be stressful)
  • Even if your portfolio grows to become very large, the fund is still well-suited to handle it

Step #3: Enter your trade

The next step is to determine your exit strategy.

Slow and Steady Wins the Investment Race

It’s the old adage that most investors know: Slow and steady wins the race. If you have looked at your investment portfolio recently, you may have wondered what is the point of investing if it seems like you’re always behind, whether compared with the Dow or floating in the market?

Investing in an index fund is one approach to slowing down the race. But, like all financial advice, this strategy isn’t always as simple as it sounds.

If you’re like many investors, you’ve probably heard index funds are the way to go in the market, especially now that the economy has been recovering for several years.

But where should an investor start when it comes to index funds?

What are the best index funds?

Do index funds perform well in all markets conditions?

Are there any downsides?

We’re going to explore these questions in this piece, beginning with the basics on how to invest in an index fund and progressing even deeper into some other related questions.