But 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 briefly explain why stock market index funds are so popular and show you how you can easily buy one on your own.
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.
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!
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