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How to Buy a Stock Market Index Fund

April 4, 2012 by MMD 35 Comments
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What exactly is an index fund? If you buy one, what are you actually getting? And why do so many experts unanimously recommend that you invest in them for your retirement? In this post, we'll explain all of this and show you how to buy an index fund the easy way. Learn more at MyMoneyDesign.com

If you’re wondering how you can buy an index fund, then you’re in the right place!

Index funds have become a favorite investment choice for people from all walks of life. Thanks to their simplicity and performance, you could easily grow all the money you’ll ever need by consistently investing in an index fund.

Even legendary investment guru Warren Buffett famously bet (for charity) a group of hedge fund managers that they could not outperform a simple index fund. And you know what? He was right!

Even though these guys were supposed to have all the right connections and information to beat the market, they still managed to lose to an index fund. 10 years later, the index fund gained a 94% return while the hedge fund only gained 24% according to USA Today.

So does this mean you have to be as rich as Warren Buffett to buy an index fund?

No! Absolutely not. In fact, that’s one of the beautiful things about these types of investments. Anyone can buy an index fund!

But even if you do buy one, what exactly are you getting for your money? And why do so many experts constantly recommend them if there are SO MANY other investment options to choose from?

That’s exactly what I want to explain to you in this post. First, we’ll briefly cover what an index fund is and why they are so popular. Then, we’ll show you exactly step by step how you can buy your first share of an index fund.

 

First of All, What is an Index Fund?

When someone refers to an index fund, usually they’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 9-10%.  Although a positive return is NEVER guaranteed when it comes to stocks, history shows us that given enough time (usually 10 or more years) this can be a very attractive figure for growing your investments.  (Click here fore the S&P 500 Wikipedia page that has dozens of return rates over the years.)

 

Why Are Index Funds So Popular?

We could write a book on this topic, but I’ll sum it up like this:

There is a popular opinion that it is impossible for the average investor will never be able to beat the average 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 You Can 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.

buy an index fund

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!

 

Photo credit: Pexels

Filed Under: Stocks & Investing Tagged With: 500 Index Fund, Index Fund, mutual fund, New Investor, S&P 500, Vanguard, VFINX

Reader Interactions

Comments

  1. Bichon Frise says

    April 4, 2012 at 12:29 pm

    The other advantage of index funds are they help to reduce risk. For instance, if you were heavily invested in 5 of the top 10 companies in the S&P 500, if one of the companies you invest in goes under or has a negative event happen, it hurts much more than if you own the entire index. In other words, index funds help to reduce risk while fetching returns as good (after fees) or better than actively managed funds (there are a few examples of active funds doing better, but how do you pick them?!).

    Reply
    • MMD says

      April 5, 2012 at 5:41 am

      Very good point about risk! There are many people who write off mutual funds and index funds as boring claiming they can get a better return. But I shutter to see just how low their poor choices drag their portfolios. Unless you have Warren Buffett or Peter Lynch level skills, it is unlikely that you will ever do better yourself over the long haul.

      Reply
  2. Liquid Independence says

    April 4, 2012 at 12:58 pm

    Indexing combined with re-balancing occasionally is the best way to go. Vanguard is probably the best choice in the US. I wish our MER fees in Canada were as generous :(.

    Reply
    • MMD says

      April 5, 2012 at 5:45 am

      What is a popular broker for Canadians to use?

      Reply
      • Liquid Independence says

        April 5, 2012 at 2:34 pm

        We can use Vanguard as well but our products are a little more expensive because we lack the economy of scale. Our other options are iShares, Horizons, and BMO.

        Reply
  3. Katie says

    April 4, 2012 at 8:52 pm

    Thank you so much for this post! I often hear that index funds are great and I’ve been wanting to set up a Roth IRA. I am so glad that you posted a step by step on how to do this. Now I won’t feel clueless when I go to set up a ROTH.

    Reply
    • MMD says

      April 5, 2012 at 5:57 am

      You are absolutely welcome! I was hoping at least one reader would find this practical and useful. Sometimes people who have done investing for a while take for granted what they know about picking funds or even something like where to find them. I remember the time I sat down to navigate through the Vanguard and Fidelity websites I thought “What a mess! What are all these numbers and charts? Where do I ACTUALLY buy something! Frustration!!”

      Reply
      • Katie says

        April 5, 2012 at 8:07 pm

        Is there a minimum amount of money you have to invest to buy a index fund and open up a Roth IRA?

        Reply
        • MMD says

          April 5, 2012 at 11:00 pm

          There sure is! The Vanguard 500 Index Fund has a minimum investment of $3,000 no matter whether you are starting a regular investment fund or IRA. When you go to the site and click on the fund, click on the tab that says “Fees and Minimums”. The good news is that once you make your initial investment, you can setup re-occurring investments as low as $100.

          Want an EVEN cheaper one? Go to the list of Vanguard funds and click on the Vanguard Star Fund. It only costs $1,000 to start out – by far the cheapest starting cost for a mutual fund! This is another low expense fund that invests in a good mix of stocks and bonds – technically it is “safer” than the Vanguard 500 Index Fund. I bought each of my kids some shares of this one.

          Reply
          • Katie says

            April 7, 2012 at 10:45 am

            Thanks for all of the information. It’s very helpful to me. It shouldn’t take me too long to save a $1,000, so I may just try that first.

            Reply
            • MMD says

              April 8, 2012 at 10:37 am

              No problem! It sounds like you’re on track!

              Reply
  4. Get Rich Point says

    April 5, 2012 at 1:59 am

    I don’t have an index fund but, I have a portfolio of real shares resembling a lot to an index fund.

    Reply
    • MMD says

      April 5, 2012 at 6:00 am

      An interesting strategy. How many companies do you hold out of the index? Do you feel as though this gives you better control over your holdings? Do you see a better return using this strategy? Are your stock commissions cheaper than the expense ratio of the mutual fund?

      Reply
  5. Karunesh @ chase-a-dream.com says

    April 5, 2012 at 12:14 pm

    I already have invested a lot on index fund, but now I am becoming greedy. I want more returns. I am trying to pickup market trends on my own so that I can choose my stocks. Thanks for sharing

    Reply
    • MMD says

      April 5, 2012 at 10:46 pm

      Karunesh: Although most of my money is safely invested in boring mutual funds, I too am getting antsy for some glorious returns – especially after the +60% appreciation of my Apple stock. I keep a few thousand in my brokerage account just for trying my hand at becoming the next Warren Buffett!

      Reply
  6. Young Professional Finances says

    April 5, 2012 at 1:45 pm

    I’m just starting to learn about investing and this is a great guide to index funds. I like that you actually gave a step by step guide on how to buy an index fund – thanks for the tips!

    Reply
    • MMD says

      April 5, 2012 at 10:46 pm

      You’re welcome! I hope you can put it to good use!

      Reply
  7. Shilpan says

    April 5, 2012 at 10:12 pm

    Vanguard is best when it comes to no load index fund. I like your choice of VFINX. With ETFs, now you can invest in index funds of emerging markets too.

    Reply
    • MMD says

      April 5, 2012 at 11:02 pm

      I have yet to figure out which is your best bet in terms of overall cost – the ETF or mutual fund. I have heard arguments both ways. The emerging markets option is very interesting!

      Reply
  8. BusyExecutiveMoneyBlog says

    April 5, 2012 at 11:53 pm

    MMD, You are spot on! Index investing is the way to go. One of the biggest challenges, investors have is getting too emotionally attached to their individual stocks. This attachment clouds judgement and leads to bad decisions. Within index funds (I use ETFs), there’s no level of emotion as you are buying the market.

    Reply
    • MMD says

      April 6, 2012 at 8:31 pm

      I totally agree. I’ve never felt any attachment to my index funds (or any mutual fund for that matter). But stocks are different. It’s the end of the world if they don’t pull through. Too much emotion indeed!

      Reply
  9. ShortRoadTo says

    April 6, 2012 at 6:21 am

    Another great option is the Vanguard Total Stock Market Index fund (VTSMX). With this fund, you are investing in All the stocks in the U.S. Stock market.

    Reply
    • MMD says

      April 6, 2012 at 8:34 pm

      Talk about diversification! How is the expense ratio?

      Reply
  10. Jessica says

    April 6, 2012 at 12:52 pm

    I currently own several shares of Vanguard’s SP 500 Index Fund. Index Funds definitely simplifies the investing process. Great post!

    Reply
    • MMD says

      April 6, 2012 at 8:56 pm

      That is what makes it so great! You don’t have to know anything about investing to capture the average return of the market.

      Reply
  11. The Kechi One says

    April 24, 2012 at 9:16 pm

    Good article! I’ve been wondering where to put my next few dollars. I need to research more about starting an IRA, or Roth IRA from overseas. I’m still not sure what the tax implications are for me with 100% of my earnings made and taxed outside of the States.

    Reply
    • MMD says

      April 25, 2012 at 11:56 pm

      Ouch – I wish I could be more helpful, but I’m not sure what the international implications are on taxes and income.

      Thanks for the compliment! Does your blog really have an Alexa ranking of 844, or is my toolbar broken??

      Reply
  12. Tim says

    April 25, 2012 at 1:14 pm

    Would it be a bad idea to buy index funds right now when the market is back to around a high peak (eg its nearly 1400 right now for the S&P..with its highest recorded being around 1565?). Perhaps a cycle will occur again with another dip in the stock market yielding lower buy-in values, at which point it would be a better idea to jump in. Or is it better to invest now at what I feel is pretty high and just hope the ticker keeps climbing in the long haul?

    Reply
    • MMD says

      April 26, 2012 at 12:12 am

      Welcome to the site Tim! If I knew the answer to your question, I would be raising thousands of dollars to place on the market when it was the optimum time to buy. But unfortunately, no one knows when that will be. This is called “timing the market” and it is just not possible to do. No one knows how the market will do tomorrow.

      My advice is that whenever you’re interested in a new fund, just buy it. Don’t wait. The second you decide to wait, the fund will probably start going up. And of course the second you buy it, the fund will then go down. That’s life with investing. But keep a thick skin. As long as you’ve got time on your hands, you’ll always be doing exactly the market average. Given the historical 8%, I’d say that’s not bad.

      Reply

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