How to invest in index funds as a beginner
Investing in index funds is not as daunting as it may sound. With the right information at your fingertips, you can make returns from your investment. There are many index funds to choose from. In this article, we show you how you can start investing in index funds. Let’s get into it!
To invest in a index fund, you need to follow these steps:
- Choose an index
- Select a fund from the index
- Invest in the chosen index fund
Choose an index
What is an index? This is a standardized way of tracking the performance of assets. There are many indexes that you can choose from and may ETFs and mutual funds tend to track indexes in a bid to offer exposure to investors.
Indexes can be divided into
- Global indexes
- Regional indexes
- National indexes
1. Global indexes
As the name suggests, they track group of assets from around the globe. A perfect example is the MSCI World Index that tracks large to mid-cap equities from developed countries. Other popular indexes include Dow Jones Global Titans 50, S&P Global 100 Index, and S&P Global 1200 Index.
2. Regional indexes
They track assets from specific regions such as Europe, Asia, or North America. They are usually beneficial to investors that are keen on investing on regional companies. They compare the performance of companies from different countries within the region.
In Asia, you can find the FTSE ASEAN 40 Index and S&P Asia 50 Index. In Europe we have the Euro STOXX 50 Index and FTSE Euro 100 Index, among others.
3. National indexes
They track assets within a specific country. Ideally, they track large companies within the country rather than small companies. However, in some countries, small-cap stocks are tracked since there are no large companies.
Top national indexes include SSE Composite Index (China), S&P/TSX 60 Index (Canada), ITEL Index (Brazil), and NSE of India Index (India).
As you can see, there are hundreds of indexes you can choose from. If you want to invest in national indexes, you can consult with local authorities, for global indexes, you can refer to their website as well as regional indexes.
Open an account
If you don’t have a trading account, then you cannot buy index funds. Luckily, you can choose from a wide array of accounts. Some of the most popular are:
- Retirement accounts that include Roth IRA, IRA, and 401(K)
- 529 plan account
- A taxable account with a broker.
Choose an index fund
Armed with the desired index, it is time to choose the most appropriate index fund. Here, you need to consider your budget to make the right decision. Depending on the index you chose, you might be exposed to hundreds or tens of funds.
However, you need to consider your budget. Ideally, you should opt for those that are cheap to run. You should also consider restrictions that can bar you from investing in the index fund.
Cheap index funds often attract a fee which is deducted from your returns. They are not managed by some of the best analysts so you have to do your calculations right. Some of the aspects you need to consider when choosing an index fund include:
1. Account minimum
Most brokerage firms have an account minimum of $0.
1. Investment minimum
Investment minimum can vary from company to company. In fact, running a mutual fund can cost you up to thousands of dollars. That said, a company can allow you to pay an investment minimum in small portions when you reach a certain threshold.
3. Expense ratio
This cost is deducted from your returns as a percentage of your investment. This ratio varies depending on a mutual fund. For example, you can get a 0.09%, 0.58%, or a 0.07%.
4. Tax-cost ratio
This cost is applicable if you hold your funds outside IRA and 401(K) accounts. They also deduct a heft amount from your returns.
Purchase your index funds
With everything in place, it is time to buy your first index funds. As mentioned, you should consider the investment and account minimum for each fund you purchase. Also, keep in mind the overall cost as this can accumulate in the long run. Purchasing the funds can be done through a broker or directly from the company.
Crucial aspects to consider are:
Cost: Does the fund or broker charge a commission per transaction? If so, is it cheap or expensive compared to other funds?
Convenience: well, does the broker offer all the required trading tools and insights? If you opt to invest in mutual funds, is the company offering all you need for seamless trading? Ideally, you need to opt for a provider that is more like a one-stop shop.
Different funds: another aspect to consider is fund selection. In that, does the company allow you to choose different fund families.
Come up with an investing strategy
If you want to create wealth investing in index funds, then you need a long-term strategy. It also allows you to make purchases devoid of emotions or swings in the market. as such, you minimize instances of buying shares at a high price or at a loss.
While trading is important, you should not overlook reviewing your investment after a specific period. This allows you to relocate investment so that you can stay abreast of your investment goals. And if you don’t have time to review your investment, a robo-advisor will do it for you.
Most brokers offer this service. It is cheap and saves you the legwork of keeping track of your investments.
Come up with an exit strategy
When it comes to releasing your shares, how will you do it? Do you have a plan? If not, you need to come up with one. For example, if your funds are in a taxable account, you need to consider the capital gains taxes.
It is advised you hold your investment for more than a year to avoid heft taxes. On the other hand, funds held in accounts such as IRA, do not attract capital gain taxes.
Why investing in index funds is beneficial
- Time spent looking for stocks to buy is reduced significantly. This is because you can seek the services of a fund manager to help you find the best stocks in a specific index. Also, since it is a long-term investment asset, you don’t have to keep abreast with the news or looking at graphs which is the case with stock trading.
- The risk involved in investing in index funds is significantly reduced. You are exposed to hundreds of stocks to buy from hence improving your diversification. And with diversification comes less risk of huge losses.
- Index funds are relatively cheaper to manage compared to other investment options. For example, a fund manager will only need to choose stocks from a given index. The best part, they do not charge for this service.
Top index funds that you can invest in:
1. Vanguard S&P 500 ETF
If you are looking to buy index funds from a reputable ETF, consider this index fund. It tracks the S&P 500 index that contains some of the largest companies in the world. The ETF started operating in 2010 and has gone on to be worth more than hundreds of billions. It falls under Vanguard which is one of the leading fund companies in the world.
2. Schwab S&P 500 Index Fund (SWPPX)
While smaller compared to Vanguard S&P, it has billions of assets under its belt. Thanks to its longevity which dates back to 1997, it is one of the most preferred Index Fund in the market. Charles Schwab is the sponsor behind the index fund. Its expense ratio is 0.02%.
3. T. Rowe Price Equity Index 500 Fund (PREIX)
As you can see, investing in index funds requires research. This is to mitigate instances of investing in the wrong index funds. You can choose local, regional, or global index funds depending on your risk tolerance. It is recommended you invest in blue-chip index funds since they are stable.