Index funds are increasingly popular with investors, especially those just starting out. Investing in an index fund is an indirect way to buy into the whole market.
What exactly is an index fund?
An index fund is a type of mutual fund whose holdings match or track a particular market index. Each index fund is based on a stock market index like the S&P 500, Nasdaq, or Dow Industrial Average.
It buys all the stocks that make up the index and in the same proportion. Index funds provide a broad market exposure because they invest in all the stocks that make up an index. So, they are usually well diversified.
They also have a low portfolio turnover, which means they don’t buy and sell stocks very frequently.
Usually, index funds have low expense ratios or low overall costs thanks to the low portfolio turnover, and they don’t have to hire research analysts that will do the research to decide which stocks to buy or sell.
Index funds are increasingly popular with investors, especially those just starting out. Investing in an index fund is an indirect way to buy into the whole market.
Once you’ve prepared to start, it’s easy to get going.
First thing you want to do is open a brokerage account. Setting it up is simple and you can typically complete an application online in under 15 minutes. There are plenty of online brokerage companies to choose from. E-Trade, Charles Schwab, Fidelity, and TD Ameritrade are just some of the options available.
Once you’ve opened the account, you will need to fund it by linking your bank account to your brokerage account. You might be asked if you want a cash account or a margin account. A margin account allows you to borrow money from the broker to make trades, but you'll pay interest and it's risky. Generally, it's best to stick with a cash account at first.
You can then set up an automatic withdrawals from your checking account into the brokerage account and fund your investments on the regular. Most brokerage account companies don’t require a minimum dollar amount to open an account, however, an investment minimum might be found in an index fund, in which you would have to buy, say, $1,000 in shares to take part in the fund.
Keep in mind your funds may incur capital gains tax on investment income; investments sold 1 year or less after buying are subject to ordinary income tax. The account is primarily used for trading, options trading, and any additional long-term investments. Contributions are unlimited and there are no limits or penalties on withdrawals.
Investors can buy funds that focus on companies with small, medium, or large capital values, or focus on a sector like technology or energy. These indexes are perhaps less diversified than the broadest market index, but still more so than if you were to buy stock in a handful of companies within a sector. They help to diversify your portfolio by spreading risk around and give investors greater choices among conservative and riskier investments.
Index funds are easy to understand. Investing can be daunting for those with no experience. They promise to track the financial progress on the index to which they are tied to, so what you see is what you get. One of the great qualities of index funds is that they tend to rise over time, whereas individual stocks may rise and fall. So, for those who want to “set it and forget it”, index funds are the way to go.
Furthermore, when compared to a mutual fund, index funds are the better option. Managing a mutual fund requires making daily (sometimes hourly) investment decisions. One of the differences between index and regular mutual funds is who’s behind the scenes making the shots. There’s no need for active human oversight to determine which investments to buy and sell within an index mutual fund. So, if a stock is in the index, it will be in the fund, too. Because no one is actively managing the portfolio, performance is simply based on price movements of the individual stocks in the index and not someone trading in and out of stocks. Therefore, index investing is considered a passive investing strategy.
Whether you're new to investing or already experienced, an index fund is a great asset to add to your portfolio. It doesn’t take much effort to find the right one for you, but once you do, you can just sit back and let your money work for you. If you find yourself needing a push in the right direction, reach out to a financial coach today. A coach helps you stay on track to meet your goals and continue to make progress. Text, call, or email today!
