How to Invest in Index Funds for Dummies
Contents
- What are Index Funds?
- How to Invest in Index Funds
- Benefits and Limitations of Index Funds
- Limitations
- What are the Best Index Funds to invest in?
- Conclusion
As late as 2016, more than $1 out of every $5 invested in America was believed to be invested through an index fund. By buying into an index fund, you get a well-rounded selection of many shares in one package without having to buy each individually. For this reason, management fees tend to be low which translates to higher investment returns for individual investors.
What are Index Funds?
The index part of an index fund refers to a list of stocks or bonds that are put together based on a particular criteria. An index, is an evaluation of the fluctuations in the performance of a group of stocks. That is, a collection of stocks that act as a benchmark for the stock market as a whole. Some of the most popular index funds include the Dow Jones and the S&P 500. For instance, if you buy into the Dow Jones index fund, you will purchase shares of all the stocks included the Dow Jones index fund.
How to Invest in Index Funds
Here are the steps you should take to get started in Index investing.
Step 1: Decide where to purchase your index funds, a mutual fund or a brokerage. Look out for things such as commission-free options, convenience, and trading costs.
Step 2: Choose your index fund. There are very many index funds in existence today. A great example is the S&P 500 Index that tracks the stocks of 500 companies. Indexes or Indices, are chosen based on sector, geography, asset class, or more.
Step 3: Start investing. The biggest mistake is not to invest at all. The truth is you’ll never be prepared enough, or know everything. But by investing now, you will start learning more about investing in index funds.
Benefits and Limitations of Index Funds
Benefits
- Simplicity: Index funds just track the market. Therefore, they are much easier to hold than traditional mutual funds. Furthermore, results show that index funds tend to perform extremely well. However, this doesn’t mean that losing money is an impossibility. If you invest in an index fund that isn’t performing, don’t expect great ROI.
- Low-Cost: With an index fund, you don’t have a fund manager who’s trying to beat the market. Everything happens passively. Thus, you end up saving on management and transaction fees.
- Diversification: It doesn’t get any more diversified than this. Index funds can have even up to 3,000 global stocks in one index. They offer great diversification features than other asset classes individually.
- Consistency: Investing in index funds is all about passive investing. Active investing takes a lot of time and effort to track each stock. Thus, it’s pretty challenging to be consistent. However, investing in index funds makes it easy to stay consistent.
- Clear picture: Index funds tend to give you a clear picture of the whole portfolio rather than breaking down each individual underlying component.
Limitations
- Lack of Flexibility: This applies to when a particular index is declining strongly. For instance, if the returns of a certain index are falling, there are very few options that an investor can undertake to limit those losses. An investor holding single individual stock has more flexibility in finding better-performing shares in such times.
- No Big Gains: By investing in index funds, you are literally surrendering the possibility of massive returns. This is because top-performing index funds perform way better than top-performing index funds. Additionally, the best non-index funds can perform way better than an index fund in a year.
What are the Best Index Funds to invest in?
Investing in index funds is one thing, but finding the best index funds is another. There are many index funds available today. Thus, it can be quite challenging finding the best one. Some of the best index funds to invest in include:
- Dow Jones
- S&P 500 Index fund
- Vanguard Total Market ETF (VTI)
- Vanguard Total World Stock ETF (VT)
- Vanguard S&P ETF (VUSA)
- Vanguard FTSE All-World UCITS ETF (VWRL)
Conclusion
Expert investors such as Tony Robbins and Warren Buffet always recommend that you start out investing in index funds. This only means that index funds are a sure way to success in the investment field. Thus, make a bold move today and invest in index funds to enjoy all the benefits that come with index funds. Remember to always remain wise in any of the investment choices that you make.
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