How To Invest In Index Funds
Whether you’re just getting started with investing or even planning to invest for retirement, there’s a lot that can be confusing …
Which investments should you pick? Which ones won’t lose my money? How do I actually go about buying them?
Thankfully, there’s one thing you can buy that will satisfy each of these questions and make the process a whole lot easier – Choose to invest in an index fund.
Why Should You Invest In Index Funds?
Index funds have continuously been proven to be a radically simple way for the common investor to capture the average returns of the stock market without all the fuss and hassle of actually researching each and every company. It’s a strategy that has become so popular that it is even backed by world-famous stock guru Warren Buffett.
Sounds good so far, right? But what exactly are index funds? And why do they come so highly recommended?
What Is An Index Fund?
Index funds are really nothing more than a select group of investments that people use to determine how the market performed that day. You’ll also often hear them referred to as benchmarks.
The first well-known index to be created was the Dow Jones back in 1896 by Charles Dow. Rather than try to average the stock price of every single company available, Dow chooses a much simpler approach by looking at only the top 12 companies. The logic was that their performance would serve as a sort of “litmus test” for representing how the overall market behaved that day.
Eventually the idea caught on, and more and more people started talking about the stock market in terms of “indices” rather than by the individual stocks.
Today, there are many different types of index funds for nearly every niche of stocks and bonds. In terms of large-cap stocks, the most widely popular benchmark is the S&P 500 index. These are the top 500 largest and best performing U.S. companies.
How You Benefit From Index Funds
For years, people have been putting a lot of time and effort into trying to pick the best companies to invest in. But as anyone can tell you, that’s no easy task! It ultimately involves a lot of research and risk-taking that the majority of people aren’t prepared to take.
It wasn’t until the 1970s until a man by the name of Jack Bogle (the founder of Vanguard) popularized a very simple idea: All the best companies are already identified in a market index. Therefore, if you just invest in the index, then you will always be able to capture the average return of the market.
In other words:
You’ll make more money over the long-term by simply investing in the index fund than you will be trying to pick your own individual investments.
Since then, this has been proven over and over again by experts, academia, and historical fact.
Ironically, even professional fund managers whose sole job it is to “pick the right funds” have not been able to beat index funds. According to CNBC, even as of recently, 85 percent of large-cap funds underperformed in the last 10 years, and nearly 92 percent are trailing the S&P 500 index over the last 15 years.
The lesson to be taken away from all of this is clear. The average investor can easily bypass trying to “pick the right funds” and earn a decent return if they just put their money into an index fund.
How To Purchase An Index Fund
So how exactly does someone go about purchasing an index fund?
Almost every major financial service provider now offers some version of an index fund. For our example, we’ll go to Fidelity Investments and walk you through exactly how this is done.
Find The Right Index Fund
First, go directly to Fidelity’s website. Along the top menu, hover over “Investment Products” and then click “Mutual Funds”.
Next, in the middle of the page, click “Explore Fund Offering”.
Under “Explore the full spectrum of available Fidelity Funds” click the “Index” tab. Scroll down and you will see a complete list of all the various index funds that Fidelity currently offers.
As we said, not all index funds track large-cap stocks. However, if you’d just like to simply purchase a basic index fund that does track the S&P 500, then look under “Domestic Stock” for the fund “Fidelity 500 Index Fund (FXAIX)”. Click on the ticker symbol FXAIX and you will be taken to the fund profile’s homepage.
Here, you can learn a lot of details about the fund. For example:
Snapshot – The latest fund ratings from companies like Morningstar.
Performance – How has the fund done this year, last year, over the last 10 years, etc.
Details – Important information such as what the types of securities the fund invests in, how long its been in operation.
In particular, under this section, there are two important things you’ll want to look at:
- Minimum Investment – Unlike a lot of other funds that typically require $1,000 or more to get started, there is no minimum amount needed to make your first investment.
- Expense Ratio – Currently 0.015%. That means you’ll only pay $1.50 every year for every $10,000 you invest. That’s ridiculously cheap!
Other Information – In the middle of the page, there are some additional tabs (Performance & Risk, Ratings, Composition, etc.) that will give you even more detailed information about the fund. I encourage you to explore each of these so that you get a better understanding of what you’re purchasing.
Buy The Index Fund
If all looks good and you’re ready to make your purchase, click the green “Buy” button at the upper right corner. If you haven’t already, you’ll be asked to create a profile and set up a brokerage account (a temporary place where you can move money into Fidelity and use it to make purchases).
If you don’t already have an IRA, now would be a very good time to set one up while you’re making your purchase.
Depending on which type of IRA you qualify to open, such as a Roth IRA, you could use this money to offset your taxable income, which would reduce your tax bill for the year. Besides, your funds will also grow and compound over the years without you having to pay taxes on the gains and dividends every year.
If you’re already all set up with Fidelity, then all that’s left is to confirm your purchase and then that’s it … you’re now an index fund investor!