How to Buy Index Funds

 One investment that has become popular in recent years is known as an index fund. It's a mutual fund that holds shares of stock from each of the companies listed in a particular "index." An index is simply a list of companies that share some trait, such as company size, geographical location or type of goods or services produced. Examples of an index include the Dow Industrials, the S&P 500 and the NASDAQ Composite. An index fund passes along to its investors whatever profits or losses its listed companies yield. Such funds are widely considered to be a relatively safe and stable investment. You can buy index funds through mutual fund companies or investment brokers. The following article will help you get started.

 

Part 1

Choosing Index Funds

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   Choose an "exchange-traded fund" (ETF) if you do not have a lot of money to invest. Such funds often require a very low initial investment. Some ETFs track an index of major companies. One such index is the S&P 500, which lists the 500 largest companies on the New York Stock Exchange, companies like Apple, Microsoft, Google, Chevron and Bank of America. Large-company index funds are often a good bet, because the stability of these companies is firm, and you will likely get a respectable return on your investment. ^[1]

   • Using an index fund will make it easy for you to start an investment without having to pick and choose individual stocks on your own.
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   Seek a higher potential return-on-investment by choosing a "mid-cap" index fund. Mid-capitalization refers to medium-sized companies, which represent potentially larger investment gains than do the more prominent companies that have already achieved their growth.
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   Try "small-cap" index funds for an even bigger possible return. Smaller companies have more room to grow and thus offer a higher potential return-on-investment. However, they also represent a higher risk of loss.

   • All mutual funds represent some risk to the investor. Choosing to invest in a small-cap index fund is a good way to blend the higher risk/return potential in smaller companies with the increased level of safety contained in the index format. ^[2]
   • Spread out your investment by putting a larger portion of it into mid-size index funds and a smaller percentage into small-cap index funds.
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   Use index funds as part of a diversified portfolio. You can invest in index funds as part of a larger portfolio that contains both mutual funds and other investments. Index funds can be added to a portfolio to strengthen it through diversification. The more stocks, bonds and other assets your portfolio contains, the less any single failure can hurt you. ^[3]

   • The mutual fund company or the broker through which you buy an index fund can tell you how to add it to your existing portfolio or how to create a new portfolio that includes index funds.
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   Check to see that your fund's return closely matches the return on the index associated with the fund. You can find the fund's return on its website or by asking your broker. Check to see that the fund's return matches or exceeds that of the associated index. If not, the fund is failing you. Consider switching to another fund.

   • Invest only in index funds where the index is stable and provides a return healthy enough that it covers the cost of the fees for the fund -- including any brokerage fees you pay. ^[4]
   • Avoid index funds that have a history of not performing well or providing a return consistent with the market.
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   Make sure you can afford the index fund's minimum investment. Many index funds will require an opening investment of at least 2,000 US dollars. Think of this as a cover charge that gets you started on a path toward your financial goals. Also, only invest money that you could afford to lose—never invest money you'll need to use for things like rent or bills.^[5]

   • At some mutual fund companies, you can open an ETF account (exchange-traded fund) by investing nothing more than the price of a single share (which might be a few hundred dollars or less). ^[6]
   • The investment minimum can be higher or lower depending on the fund. The investment firm or broker can break down the investment minimums for different funds and try to find one that is within your budget.
   • Be sure you understand the costs that are associated with buying the index fund, as well.^[7]

Part 2

Purchasing Index Funds

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   Buy from mutual fund companies who offer a range of index funds. Many mutual fund companies will have a selection of index funds you can choose from. Vanguard, BlackRock and State Street Global are all considered market leaders for index funds. Examine a company's list of funds and their historical returns before you commit to a particular fund. ^[8]

   • Going through a mutual fund company (instead of a broker) may be ideal if you plan to contribute small amounts periodically to a fund, as you typically will not be charged transaction fees for such deposits.
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   Consider purchasing a fund through a broker only if you're making a one-time investment. Most brokers charge a transaction fee every time you put money into a fund, so you might use this option if you plan to send money to the fund just once or very infrequently. This would also be an appropriate option if you already have a brokerage account or want to work with a particular broker rather than a large mutual fund company. ^[9]

   • Keep in mind most brokers will also charge a small commission to process your purchase.
   • Some brokers will offer free trades with no commission fee if you trade with them often or are a loyal client.
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   Provide your banking information. You will need to provide the account and routing numbers for your bank account so you can collect returns on the index fund. The mutual fund company or broker may also need to access your bank account in order to collect your opening deposit and subsequent contributions.^[10]

   • Provide your banking information only to a company or individual you trust. If you are submitting this information online, make sure the site is secure and there are protections in place.
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   Pay the fees associated with the index funds. Index funds usually have low fees and are cheaper to run than other mutual funds. This is because the managers don't have to look for stocks to buy -- they merely buy the stocks listed in the index. Compare the "expense ratios" of various index funds before you buy any.^[11] Initial expenses like these will cut into all of your future earnings. The mutual fund company you buy from or your broker can explain all fees associated with a fund. Choosing a low-fee fund is an important step in maximizing the return on your investment.^[12]

   • In general, fees for an index fund offered by a large company will amount to 0.1 or 0.2 percent of your investment. This is quite a reasonable fee compared to the return you can expect to make.
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   Pay any other initial costs associated with the fund. You will make an opening deposit just once in order to get started. If you work with a broker, you'll pay a commission every time you buy shares (and possibly when you sell shares, too).. If you work through a mutual fund company instead of a broker, you will not pay commissions. That's an important consideration. ^[13]

Part 3

Getting a Good Return-on-InvestmentDownload Article

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   Check on the status of your index funds at least once a year. Many index funds can be managed online through a portal set up by the mutual fund company or through your broker. Index funds are usually pretty stable and should not fluctuate more than the index does. Get in the habit of checking on them at least once a year so you can see whether they are doing well and you are getting a good return on your investment when compared with market conditions.^[14]

   • You should also look at whether your return-on-investment could be higher if you try a different index fund. You may want to switch to a different index fund after several years to increase your returns.
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   Add money to your fund(s) in small amounts to increase your returns. Get into the habit of adding a small portion of your income into your fund(s) once a month or several times a year to increase your returns. (In the U.S. this is known as "dollar-cost averaging" and is a proven way to accumulate more fund shares in a shorter period of time.) You can also add money to the funds if you find yourself with extra discretionary money. ^[15]

   • If you deal directly with a mutual fund company, they will usually not charge you a transaction fee when you add to your account. A broker, however, may charge you a fee or a commission if you go through them. In that case you may want to add larger amounts less often to avoid paying frequent fees.
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   Sell your index funds if they are not performing well. If you are not happy with your index fund(s) or want to try a different investment, sell them through your mutual fund company or your broker. Most mutual fund companies and brokers will charge a small fee for you to trade the index funds, around $10 per trade.^[16]
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   Cash out the index funds if you need income or want to shift your investments. You may decide to pull out some or all of the money in your index funds if you need it to pay expenses. You may also decide to cash out if you want to shift your investments to another mutual fund or to stocks. Your mutual fund company or broker can help you cash out the funds. They may charge a small fee.

   • Carefully consider any such cash withdrawal before you go ahead with it. Every time you redeem shares (withdraw money) from a fund, that money will have no chance to grow should the fund make future gains. Remember that investing is traditionally considered a long-term project.