One of the frustrating concepts a new investor can come across is when people talk about an Index Fund. [Sarcastic Dad Voice ..] “Index funds are great!” “You can’t beat an index fund!” – That’s all fine and good, but what exactly IS an index fund? And if they’re so awesome, where does one go to actually buy an index fund?
That’s exactly what I’m going to show you in this post. We’ll briefly explain the love affair people have for index funds and I’ll show you where to buy one for cheap!
What is an Index Fund?
First things first, when we (or most sites) refer to an index fund, we’re talking about the S&P 500 stock market index. The S&P 500 (along with the DOW and NASDAQ stock indexes) is one of the three major figures that are constantly reported everyday on the news or papers. When the news says “the stock market was up today” or “the stock market was down today”, they are usually referring to this index.
It helps to think of the S&P 500 as holding a group of the 500 largest U.S, common stocks. Here you’ll find extremely popular companies like Apple, Exxon Mobil, IBM, Chevron, GE, 3M, all the companies that make up the Dow Jones, etc.
The S&P 500 index has been around since 1957 and has an average annualized return of approximately 8% ( you can download all the data from Yahoo Finance and calculate it yourself if you wish). Although this value is NOT a guaranteed return, it is a very attractive figure if you have a great deal of time to work with.
Why Are Index Funds So Popular?
• There is a popular opinion that it is impossible for the average investor will never be able to beat the average 8% return of S&P 500.
That’s right. You could try to pick a handful of stocks and get a better return, but there is a skyscraper of research that says there’s a high probability that you won’t be able to do it.
The other reason: Index funds are cheap!!! Could you imagine trying to buy and hold all 500 stocks yourself? You’d spend a mint!
So how cheap is to buy an index fund? For the fund I’ll recommend below, try 0.17% per year! That’s $17 for every $10,000 you’ve got invested. Try doing better than that with just about any other mutual fund!
How to Actually Buy an Index Fund:
First of all, you can’t “actually” buy an index fund such as the S&P 500 or any other popular metric. What you CAN buy are mutual funds or ETF’s (exchange trade funds) that track these indices and are very, very similar. Every broker has their own version of these funds.
For our tutorial, I am going to recommend one of the most popular and cheapest S&P 500 funds available: The Vanguard 500 Index Fund Investor Shares (VFINX).
Here are the steps to reviewing and buying an index fund:
1. Go to Vanguard.com and click on “Go to the Personal Investors Site” (middle of the page).
2. Near the top, click “Research Funds and Stocks” and then click “Vanguard Funds”.
3. Click “All Mutual Funds”.
4. On the left, un-check the box that says $10,000.
5. In the middle near the top of the list, a fund called “500 Index” should appear. Go ahead and click it.
6. Here you can review everything you want to know about the Fund: Past performance, fees, minimum investment ($3,000), risk profile, etc.
7. If all looks good, click “Buy” in the upper right hand corner. Here you’ll be taken to a screen where you can setup an account and transfer money from your bank account to pay for the purchase. BONUS: If you don’t already have one, you can also take this opportunity to setup a Roth IRA so that all the earnings you make on this investment grow tax-free!
One more note: If you’ve got $10,000 or more to invest, then you qualify to buy an index fund “Admiral Shares” which is just a fancy way of saying you’re in the high-roller club. What’s the benefit? Even LOWER expense fees: 0.06% or $6 for every $10,000. You’re basically paying the equivalent of a Subway sandwich for the privilege of owning 500 of the top U.S. stocks. Talk about cheap!
New Investors – Does this help you to buy an index fund? What else scares or confuses you about jumping into investing? Readers: What other Index Funds from other companies do you use? Has anyone found ETF’s to be cheaper than this Vanguard mutual fund?
Photo Credit: Microsoft Clip Art