Quick Guide on How to Start Investing in Index Funds

Index mutual funds are a favorite among investors as they offer a simple, diversified, low-fee, hands-off mode of stock market investing. And for a fledgling investor who’s just starting out in this big, scary industry, a little ease and stability is precisely what he/she needs. When you set out to purchase an index mutual fund, you will find lots of great options in a single package, and the best part is, you don’t have to purchase them individually. Moreover, as the funds hold every investment within a particular index – as opposed to an actively managed fund where a professional is paid to handle stock picking duties – you get away with minimal management charges (read more). So, individual investors end up with bigger investment returns.

If you want to experience all these benefits for yourself, find out how you can get started with index funds below:

1.Select Where You’re Going to Purchase Index Funds From

Index mutual funds can be bought directly from a brokerage or a mutual firm. To pick the right company or organization, pay attention to the following factors –

    ·Choice of Fund: Interested in buying index mutual funds from different fund families? All the major mutual firms have some of their rival company’s funds available, but the options tend to be rather limited compared to what you can get from a discount broker.

    ·Additional Services: A single index fund provider can fulfill all your requirements and serve as your personal investment hub as long as you stick to investing in mutual funds. But when you decide to branch out and need advanced stock screening and research tools, it’s better to visit a reliable discount broker.

    ·Account Minimum: While the account minimum may very well be $0, the investment minimum is still applicable for a specific type of index fund.

    ·Cost of Trading: If the company refuses to waive their transaction or commission fee, find out the total amount they will charge for selling or buying the index fund. Remember that mutual fund commissions usually exceed stock trading rates by more than $20. For ETFs and stocks, it’s below $10 a trade.

    2.Choose the Index

Multiple indexes are tracked by index funds. The 500 Index from Standard &Poor is one of the most popular ones as the 500 companies it tracks are all US-based large organization across different industries. However, this is hardly the only index option you have. Others are there as well along with their associated index funds. Always select the right one on the basis of:

    ·Location: Give preference to stocks trading across a variety of international exchanges or on foreign exchanges.

    ·Size of the Company and Capitalization: Think whether you want to go for a small cap, mid cap, or large cap index.

    ·Industry: Choose from any business sector, including health, technology, consumer goods, etc.

    ·Market Trends: Try to invest in emerging markets.

    ·Type of Asset: It could be cash, foreign bonds, domestic bonds, or commodities.

In spite of the numerous options available, invest in just a single index fund. An investor has to invest in just one broad stock market index for proper diversification. But if you want some more exposure to certain markets in your portfolio, you’re free to personalize your allocation.

3.Consider the Investment Minimum

A minimum investment of a few thousand dollars is required when investing in some mutual fund. But when you’re past the minimum threshold, the fund enables you to add small denominations. Some companies like Fidelity and Vanguard have their own established fund minimums, which tell brokers how much money clients must commit to upfront. However, do not worry if the minimum seems too high. It’s often better to pay a larger expense ratio when you’re starting out. If necessary, you can transfer to a low-cost fund later when you’ve crossed the minimum amount. If you want to do away with the high minimum altogether due to limited funds, invest in an ETF which tracks a specific index. Rather than purchase the main mutual fund, invest in a part of the fund instead.

4.Find Out How Fund Fees Stack Up Against One Another

Index funds are in vogue due to low prices. Since they automatically track the shifts in value in a specific index, they can be run for cheap. Still, you need to pay administrative costs. Subtract these costs from every fund shareholder’s holders as part of the total investment. Figure out the expense ratio as soon as you receive the prospectus for the mutual fund or by calling for a quote.

As a rule, larger funds command lower fees. However, you’d be unwise to think that every S&P 500 index fund is cheap. It is possible for two separate funds to have similar investment goals but vary considerably in terms of management costs. While the fractions of a percentage point might not seem like a big deal, know that your investment returns might receive a big cut from even the tiniest inflation in fees. If you take out money for covering costs, the ability of the compound interest to increase greatly over time is lost and it cannot grow.

5.Think About Taxes

The tax-cost ratio is something you should pay careful attention to, as it helps you determine how much owning an index fund affects your annual taxes. This comes in handy when you’re investing in taxable accounts rather than a 401(k) or an IRA. Any transactions committed within a mutual fund is liable to produce capital gains taxes. Such taxes, like the expense ratio, can decrease your investment returns. Such problems are evident in actively managed funds where it is common for the investors to sacrifice 0.75 percent from the average annual return compared to only 0.30 percent in returns when the put is put into an index fund. But like expense rations, never assume that the tax tab is going to be low because it is an index fund.

If you want to begin investing in index funds, you should start sooner rather than later. The more you delay, the more you will find it difficult to reap the advantages of this investment scheme. Investing money for the long haul gives it sufficient amount of time to develop and mature on its own.