A Beginner’s Guide to Index Fund Investing

Index fund investing is one of the best ways to get consistent, positive returns from your investments.

As a disclaimer, I am not a financial advisor. All the advice here is from my own experience and should be used at your discretion.

What is an Index fund

Index funds are a type of mutual funds with a portfolio constructed to match or track the components of a financial market index, such as the Standard and Poor’s 500 index according to Investopedia.

I like to think of index funds as a big basket, where every stock in that market index (S&P 500, Dow Jones, Russel 2000, etc), is put into one holding. If you buy one share on an index fund that tracks the S&P 500, you have bought that entire market index.

For example, with one share of the S&P 500 index, you bought the top 500 companies in the United States, which also make up 75% of the value in the market. In that basket will be companies like Microsoft, Apple, Google, Lockheed Martin, and the other Fortune 500a.

Index funds are great for first-time investors, as well as seasoned investing professionals for a variety of reasons.

Benefits of Index Funds

1. Simplification: Researching and picking individual stocks out of the thousands offered in the American Stock market alone can be time-consuming, and what’s worse, the money invested could drop if the wrong stocks are picked. With an index fund, you buy shares that track to whatever market index the fund follows.
2. Transparency: because the fund shows what percentage of each company makes up in the portfolio, you can easily see how the fund is performing. Beyond just that, it will track how the market is performing.
3. Great performance: The index tracks the market index. However the market index does, that is how the index fund does. Actively managed funds are one where a stockbroker is balancing the portfolio for you, indexes are passively managed. Despite this, only 3% of actively managed funds beat the index five years in a row. Most people make more money by putting money into the index than with an active investing advisor.
4. Cheaper cost: Actively managed funds can run anywhere from 1-2% in cost, while the average cost of an index fund is .015%. This difference in percentage cost (also known as basis points) can result in a $40,000 difference in just five years of returns and can cost hundreds of thousands of dollars throughout 40 years of investing.
5. Diversification: picking individual stock can be almost impossible, and the returns can be spotty. Also, if most of your investment rests in a single company and that company has a scandal and goes bankrupt, there goes all the invested money. Index funds provide a broad, and safe base to store money. Since it tracks an index, and companies rise and fall, the portfolio will automatically adjust to pick the new best-performing companies, while your holdings stay unaffected.

The 80% solution

If you are new to investing, or just don’t like personal finances, you just need an 80% – good enough solution.

For picking index funds, go with broad market fund exposure, some people in the Financial Independence community have been successfully put all their money into just one fund.

1. Vanguard 500 Index Fund Admiral Shares (VFIAX): This is the Vanguard S&P 500 index, and it the grandfather of all index funds. The index provides exposure to the 500 largest U.S. companies.

To round out the portfolio a little as well, you can pick up funds in

1. Bonds
2. International fund

With whatever brokerage you go with, they will have recommendations for which bond index’s to go with along with which international fund to pick.

When Index Fund Investing

Look at the below factors when picking your fund, and make sure it matches what you want.

• Company size. Small, mid, or big based on the amount of business they do annually.
• Business sector. What industry does the index track?
• Investment minimum. Some indexes require minimums when investing, such as $2,500.
• Expense ratio. This should be in the percentages of points, like 0.15%. This is the cost of owning the fund.

Main Take-Aways

1. Index Fund Investing is a great 80% solution when you want to safely grow your money.
2. When buying index funds, make sure the index is cheaply tracking what you are looking to invest in.

Action Item

Have you started investing yet? If not, start looking into opening a brokerage account this week and start investing some money in an index fund to get your money working for you!