Guide To Investing in Index Funds – How To Pick The Best Index Funds

For anyone looking for a way to invest that is low risk, and low stress, then index funds are certainly something to check out.

But what exactly are index funds?

They are a group of stocks that mirror both the companies and market indexes.

One of the major benefits of investing in index funds is that they are low risk and have low fees compared to funds that are actively under management.

Index funds are after all passively managed. They also have a higher yield and not to mention are super simple to buy.

If you want to learn more about what index funds are, in detail, check out our previous article!

Now without further ado, let’s have a look at exactly HOW you can invest in index funds.

1. Choose an index

Index funds track many different companies. Take the S&P 500 (standard and poor’s 500) index. It tracks 500 of the biggest companies in a variety of industries.

While it is the most well-known index, it is certainly not the only index. Indexes can be chosen based on the size of the companies and their capital, their geographical location, the industry and even emerging markets.

Simply put, you have plenty to choose from and yet all you need is to invest in a single broad market index.

2. Choose an index fund

You selected an index, now it’s time for you to choose an index fund. For the first-time investor, you should go for a low-cost index fund. These are simple and cheap to run simply because they follow the changes in the value of the index.

That said some index funds are costly. While they are also passively managed, they also accrue administration costs. These costs will be subtracted from the returns.

Note that you can have two funds that track the same index such as the S&P 500 but the costs of the funds vary. While the difference may be minimal such as a fraction of a percentage point, they can result in a huge hit especially when compounded over the years.

When choosing an index fund, you will often find that the bigger the funds, the lower the fees.

Costs that you will need to take note of include:

· The minimum investment- often index funds have a minimum investment requirement of a few thousand dollars.

· The account minimum –the account minimum is not the investment minimum. Many funds will have an account minimum of $0 but will still have an investment minimum of a few thousand dollars.

· Tax cost ratio – these are capital gains taxes that are charged on fund accounts that are not tax-exempt or tax-advantaged. They are taken out of the investment returns. For instance, the tax cost ratio could be as much as 0.3 % of the return on investment.

· Expense ratio – it is subtracted for the investor’s return on a percentage basis on their overall investment. Often the mutual fund will have its expense ratio stated in the prospectus. Stock index funds for instance may charge an annual expense ratio of 0.09%.

3. Choose where to buy

When it comes to buying index funds, you have two main options. Either you can buy from a brokerage or you can buy from a mutual fund company.

There are a few things that you will need to consider when choosing where to buy index funds.

The selection of funds – decide whether you want to buy index funds for different fund families. You may find a more limited selection with big mutual fund companies than with brokerages. However, the mutual companies may carry some of their competitor funds.

Costs of trading – it is important to compare the costs of trading from different brokerages and mutual fund companies. Keep in mind that the costs will accumulate over the years. The lower the costs the better.

The convenience – it is much better if you could work with a provider that fulfills all of your needs. If you want to keep things simple and invest in just a few mutual funds, then you may opt for a mutual fund company. However, if you want to have access to diverse tools and analytics, plus a larger variety of funds, then a brokerage is a good idea.

Any commission-free options – consider if your chosen brokerage or mutual fund company offers any non-transaction fee mutual funds or commission-free ETFs.

Things to consider when investing in index funds

While index funds offer a low-risk way to invest your money. There are also a few other things you may want to consider:

1. Is the index fund doing what you expect it to?

Keep in mind that an index fund should show and mirror how the underlying index is doing. To find out, go to the mutual fund quote page and check the index fund’s returns. Here you will be able to see the returns of the index funds over several months.

It is completely fine if the retunes are not identical. This is likely due to the investment costs that we spoke about earlier. However, if the difference is more than the expense ratio, then this should be a red flag.

2. Is the index fund too expensive?

– The best choice you can make is to invest in an ETF that will track the index. This is as compared to having to buy the mutual fund. By doing this you will be buying just a small portion of the fund.

The top best index funds to consider

First-time investors often wonder which are the best index funds to start with. These are:

· Schwab S&P 500 Index fund(SWPPX)

· Fidelity Zero Large Cap index (FZLCI)

· Vanguard 500 Index Fund-Admiral Shares (VFIAX)

· Fidelity 500 Index Fund (FXAIX)

· T. Rowe Price Equity Index 500 Fund (PREIX)

Keep in mind when investing in index funds that even while they are considered a low risks type of investment, it is still possible to lose money.

The trick is to buy an index fund and then hold it over years.

This gives you the best chance of your investment increasing value over time.