How to Invest in Index Funds

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Investing can be a scary endeavor. After all, there are a zillion different places to put your money for the long haul. Most of the time, though, if we keep our investments simple, it is to our advantage . . . both in keeping up with them and in long-term return on those investments.

One of those simpler investments is the index fund.

What is an Index Fund?

An index fund is a mutual fund that invests in the entirety of a certain index (or market). For example, the S&P 500 fund will invest in all 500 companies that comprise that index. The Nasdaq 100 fund will invest in the 100 stocks that make up that index. And so on. There are as many funds as there are indexes. Again, though, it is best to keep it simple. If you’ve never heard of the index, it’s probably best to avoid investing in a fund that “tracks” it.

Advantages of Index Funds

1. Simplicity.

You can, as an investor, know exactly what stocks (or bonds or other investments) comprise your fund. There will be no surprise investments. It is also simple to track the overall progress of your investment. If that index is going up, so is your fund. If it is going down, so is your investment.

2. Low turnover.

Some mutual funds are notorious for buying and selling all the time, making for high turnover ratios (and, therefore, fees) for investors. Because most index funds try only to stay balanced across the index, there is very little buying and selling which lowers your fees.

3. Long track record.

While index funds are a fairly new development, most of the indices themselves have been around for a long time. Just as you would with any other investment, find an index with a long and winning track record, and you can have more certainty that the index fund will continue to perform into the future.

Two Words of Caution

Before moving to how to invest, let me give two quick words of caution.

First, even though you will be diversified within this type of investment, you still need to avoid putting all your eggs in one basket. In other words, though index funds are generally good investments, one fund should not comprise your entire nest egg or college fund.

Second, some index funds have very high minimum investments (just like most mutual funds have such a range). However, many of them will waive that minimum if you enroll in an automatic investment plan. Just ask and many will be glad to work with you.

How You Can Invest in Index Funds

So, if you are interested in utilizing index funds, there are a couple of simple ways to invest.

1. Through a broker.

Of course, if you use an investment planner or broker, he or she can easily help you invest in these funds. In fact, if you are a novice investor, getting that person’s input would be a very wise move. Don’t let them “sell” you on a fund or talk you out of it; instead, take their words as some much-needed advice, but couple it with your own study and research.

If you choose to invest, be sure they help you select a fund that is no-load and that has a very low expense ratio. While those may sound like technical terms, all you need to know is that, for a fund like this – with very low turnover – there is no reason for it to cost you very much just to make and keep the investment.

2. Through the stock market.

Some index funds are traded as stocks and can be bought and sold just like any other stock. If you do your own investing, you can simply buy the stock as you would any other. Probably the most well-known is the “Spiders” stock (NYSE: SPY) that tracks the S&P 500. (Note: This is not an endorsement, but since they run commercials, you are probably familiar with this fund.) There are many of them, so do your research and remember to think long-term.

Have you used index funds in your long-term investment strategy? Leave a comment and tell us what you think about them!

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3 Comments
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  1. Dude:

    You forgot perhaps the most important advantage of index funds: LOWER EXPENSES! Since funds are tied to an index, trading is almost fully automated. This reduces the need for fund managers. Less management = less expenses and lower expenses mean a greater return. It’s a very good way to go especially since a majority of funds out there do not beat the market index.

  2. I’m still looking for any regular Joe at the coffee shop, cigar lounge, grocery store, alumni meetings, family member, online, standing on the bus, retirement luncheons, etc. that is thrilled after CASHING out of one of these investments. On the other hand, I can find in those same locations many people who have lost principal and have not yet got it back in the recent recovering market (2/2013). Obviously the media is manipulated and I feel the market is manipulated as well. The insiders make money as the market goes up and receive plenty of notice to bail before the average Joe sees the crash coming. Florida has a “docking dilemma” for yachts in this recession. Over 40 years I’ve profited from most of my investments, but the yield was never better than CDs and I did not sleep well. I’m cashed out now and sleep well.

  3. I agree, Index Funds are the best way to go from a cost as well as a diversification perspective. But I feel Joe’s pain. The professionals do have “inside” information, its called Technical and Fundamental Analysis of the markets. But don’t ever expect to hear the main stream media announce that “all individual investors need to cash in their portfolio’s now, the market is about to crash!” Jim Cramer on “Mad Money” did this in 2007 and nearly got tarred and feathered by Wall Street and probably got heat from the SEC as well. An announcement like this is synonymous to yelling fire in a crowded theater.

    There are only 2 ways to get this information. Learn how to analyze the markets yourself or pay someone you can trust that does.

    Since the beginning of the year I’ve posted 3 articles on my blog covering this subject as it relates to the current state of the market. Click on my post name, “Leo” and look for “Is the Cyclical Bull Market Over?”, “The Big Picture”, and “Bull or Bear” on my blog page.

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