Learning about stocks and how to invest in them takes you a step closer to attaining much desired financial freedom. Index funds provide you with a better and more profitable way to invest in stocks, a statement advanced and backed by tons of research. Warren Buffet, a billionaire investor is also on record advising small and large-scale investors to stick to these kinds of investments.
What Are Index Funds?
Any person who has invested in the stocks market before understands too well how difficult it can be for one to choose a single stock to invest in. Professionals who have spent a large portion of their lives studying how they operate also find it difficult and are often beaten by the stock market. This is where the index funds come into play.
While these funds may not provide the same kind or level of excitement offered by other types of investment, they are favored as they satisfy all the requirements of a good investment. This include:
- No effort
- Lowest costs
- Minimum taxes
- Maximum returns
Simply put, this type of investment refers to a basket filled with securities held within a given asset. For instance, when someone is talking about the S&P 500, they are simply talking about the 500 largest companies in the United States. This is a popular market benchmark which many venture capitalists try to match.
If you are looking to create an investment portfolio from the ground up, you will need to invest in all the 500 companies for you to successfully match this market. Alternatively, you could opt to acquire shares in a fund that will then take on the role of matching the market on your behalf.
Here, you get to enjoy the numerous advantages that come with this kind of investment without having to exhaust yourself. A similar mechanism applies to funds for different properties such as commodities, US stocks, real estate, bonds, and international stocks. Funds are mainly intended to mimic the operations of an index.
Managers in charge of operating a fund get to invest in securities using the guiding principles already at work in the market. The passive nature of these funds means managers never have to worry about routinely buying or selling stocks in an attempt to surpass the market. Their primary aim is for them to become the market.
If some of the stocks included in the index fail to perform as they are required, you don’t have to worry as the remaining stocks will offer you protection. With a fund, you get to own the whole market! Acquiring a single fund allows you to invest in all the leading companies in the country.
How to Invest in Index Funds
There’s a good reason why savvy investors tend to gush on matters related to index mutual funds: they provide them with a low cost, diversified, and hand-off option to investing in the money markets.
Any person who makes this kind of investment gets to benefit from a selection made up of a well-rounded stock portfolio. The stocks are provided as one package which means there’s no reason for you to go around buying individual stocks. Its fees tend to be low as one index gets to hold all your investments. You, therefore, get to enjoy better returns from your investment.
Looking for tips on how to invest in index funds, read on to learn more:
1. Make a Decision On Where You Want to Buy
Investors looking to invest in funds have two options: buy from a brokerage company or a mutual fund company. This also applies to ETFs (exchange-traded funds) which are similar to mini mutual funds. Their operations often revolve around the daily trading of stocks. As you contemplate on where to acquire a fund, keep the following in mind:
- Fund selection
- Trading costs
- Commission-free options
2. Select an Index
When it comes to investing with index funds you have to understand that index mutual funds tend to track different kinds of indexes. S&P is among the most commonly recommended funds as the 500 companies included in it are among the biggest in the country. It’s a fund that spans numerous industries.
However, this doesn’t mean S&P is the only option available to you; far from it. During your research, you will come to learn that there exist indexes and their parallel funds. Traditionally, this will include assets and stocks that have been chosen based on:
- Market opportunities
- Company capitalization and size
- Asset type
- Business industry or sector
In spite of all the choices available, chances are you will only need to spend your money in a single one. According to Warren Buffet, for an investor to diversify their portfolio, they will only have to invest in a broad-based stock market index. Nevertheless, you have an option to customize the portfolio if you would like to have increased exposure to certain industries or markets.
3. Check Costs and Other Investment Minimums
One of the leading reasons why the funds come highly recommended is due to their low costs. Their automation means they are not expensive to operate. But this isn’t to mean that all mutual funds are affordable or cheap. While their management doesn’t require the input of highly-paid analysts to keep things in check, they still attract administrative expenses.
The expenses are subtracted from your returns in the form of a percentage. Often the fees charged are dependent on the size of the fund, i.e., a big fund will have lower costs than a smaller fund. Some of the common costs associated with these funds include:
- Investment minimums
- Tax-cost ratio
- Expense ratio
- Account minimum
Funds to Consider
As you look forward to investing with index funds, you will need to know which funds are the best. A simple search online will reveal hundreds of indexes from different corners of the world and their accompanying funds. Nonetheless, there are those which have managed to stick out and which feature among the most recommended. They include:
Generally, these are issued by corporations and governments and are similar to an IOU. They tend to be low risk, which in turn explains why their returns are lower. Having them in your portfolio also means you get to deal with reduced risks. If looking to invest in US bonds, consider the Vanguard Total Bond Market. It’s widely renowned for investing in corporate and government bonds.
Minimum Investment: $3,000
Expense Ratio: 0.035%
International Stocks & Bonds
Buying international stocks and bonds is the easiest way to diversify a portfolio. The reason they are preferred is that their performance isn’t tied to that of US stocks. This means that just because one isn’t having a good year in terms of returns doesn’t mean the other will get affected.
Choosing to invest in the two means you have an opportunity to smoothen out your annual returns. Here, you are getting a unique opening to put money into various asset classes. These are classes that don’t compare with one another. For international stocks and bonds, consider the Schwab International Index Fund that is not only affordable but which invests in numerous countries.
No Minimum Investment
Expense Ratio: 0.06%
Real Estate Investment Trusts
Real Estate Investment Funds or REITs simply refers to funds meant to benefit investors whose eyes are on the property markets. Such funds collect money from numerous investors which are then used to acquire income-generating properties both in the local and international housing markets. They don’t have a limitation as they can also invest in commercial and industrial properties.
REITs are an ideal investment option for an investor interested in making money from real estate without having to worry about making physical purchases. If your eye is in the property markets, consider the Vanguard REIT ETF. It’s not only reputable, but it has also proven that it’s trustworthy and solid in its dealings.
Minimum Investment: $3,000
Expense Ratio: 0.12%
Options for Acquiring Funds
For those yet to get started, the best way to get the ball rolling is via your ROTH IRA and 401(k) accounts. Ensure you have maxed out both options as this will assist in reducing the amount of money you have to pay in the form of taxes. Consult with your HR department to make certain that an investment plan is set up using your 401(k). Keep an eye on the fees as certain plans will only provide you with entree to poorly performing funds.
Get yourself a broker who will provide you with assistance on how to invest in the funds via the Roth IRA. The ideal broker needs to be easy-to-use, secure, and low-cost. Potential brokers to consider are Fidelity, Vanguard, and TD Ameritrade.
Having gone through all this, you are probably wondering how you can tell the difference between a good fund and a poor one. Start by checking that the costs are below 0.20% and that their returns also match the benchmarks provided. Another thing is to set up automation to guarantee continued monthly investments, as opposed to investing once a year.