Investing in index funds has been hailed by Warren Buffet as one of the best decisions you can make. You will not be alone in that decision. According to thebalance.com, one-fifth of all the investment in the equity market in the US goes into index funds. The reason could be that index funds present investors with a wide-selection of stocks without having to buy any of them individually. They have low management fees and, therefore, affordable.
What Are Index Funds?
An index fund consists of bonds or stocks assembled on the basis of some predetermined rules. For example, the Dow Jones Industrial Average, which represents 30 stocks as selected by the Wall Street Journal as a good representation of the American economy. In the US, there’s also the Standard & Poor’s 500 which lists the top stocks on Nasdaq and the New York Stock Exchange. Investing in these and other index funds from stock markets across the world is a guarantee of low fees and high returns.
The Process of Investing In Index Funds
Step 1. Decide Whether to Buy From a Brokerage or a Mutual Fund
If you have made up your mind on investing in index funds, you need to decide whom you are going to buy from. In making this decision consider the variety of fund selection. Due to their nature, mutual fund companies have a limited selection of index funds compared to stock brokers. Also, it is important that you work with a single trader who will be able to meet all your needs. While a mutual fund has the ability to provide all your investment needs, stock brokers can help you with sophisticated stock analysis tools. Importantly, the trading costs really matter. Where possible think of working with a firm with commission-free services.
Step 2. Choose an Index
Don’t just choose an index fund because of its popularity. Youmay want to consider factors such as capitalization and company size. This is by considering whether the companies in an index fund are small, mid-sized or large companies. Looking at whether the stocks are traded on international stock exchanges is also key. The industry or business sector also matters. Don’t forget to consider whether the asset type is cash, foreign bonds, domestic bonds or commodities. The opportunities provided by emerging markets is also a key consideration. Once you have narrowed down to one option, invest in it.
Step 3. Check Costs and Investment Minimums
One of the reasons for investing in index funds is the low costs. Apart from having automated analyses, index funds are cheaper to run. But that doesn’t mean you should be complacent about it. Consider factors such as the minimum investment which can run into thousands of dollars for some options. The account minimum is also important. At the time of paying returns, brokerage firms usually charge an expense ratio, which is a percentage of the value of your investment. Another important cost consideration is the tax-cost ratio, which comes in the form of capital gains tax.
Once you have ticked all the right boxes, you can go ahead and open an account with your mutual fund or stock broker. They will manage for you the index fund so that you do not have to be in constant contact with the stock exchange.