Index funds are one of the finest investments for developing long-term wealth, according to financial advisors and famed investor Warren Buffet.
“Whether you’re investing your first dollar or have 40 years of investment management experience, I always recommend a portfolio of low-cost index funds,” said Andrew Westlin, a certified financial adviser at Betterment.
Buffett has praised the index fund on several occasions, describing it as “the most rational equity investment.”
Index funds may appear scary, but they’re nothing more than a form of mutual fund, an all-in-one investment that spreads your money across a wide range of equities and bonds. Rather than picking and buying individual equities, an investor in an index fund owns a small amount of each firm or asset, lowering total risk. Most importantly, index funds are inexpensive and consistently outperform actively managed funds.
To get started, follow these steps:
1. Review your 401(k) plan (k)
Investing in your company’s retirement plan is a good place to start. Many individuals think of their 401(k) as a savings account, but it’s actually a tax-deferred investment account. It’s just as vital to put a portion of your salary into an account as it is to decide where to invest it.
When you set up your 401(k) at work, you’ll choose a contribution rate, which is the proportion of money deducted from each paycheck before taxes and deposited in an investing account at a brokerage firm like Vanguard, Fidelity, or Charles Schwab. Your firm is likely to offer a small number of safe-bet mutual funds to pick from.
2. Open an IRA if you don’t have a 401(k).
If your workplace doesn’t offer a 401(k), open a standard or Roth IRA with a brokerage firm, bank, or other financial institution. The only difference between the two IRAs is how they are taxed, yet both offer index funds.
Even if you already have a 401(k), you may want to open an IRA because most people benefit from having both.
3. Think about opening a brokerage account.
Non-retirement accounts, often known as taxable investment accounts or brokerage accounts, are another way to invest in index funds.
Charles Schwab, Fidelity, E*Trade, and Vanguard are some of the most popular low-cost brokerage businesses. Consider using a robo-advisor like Wealthfront, Betterment, or Ellevest to open a brokerage account. Robo-advisors allow you to invest in minutes and use computer algorithms to rebalance your portfolio and save money on taxes.
Before opening an account, you might wish to shop around and check what index funds are offered through each brokerage. The majority of businesses will make it simple to compare index funds side by side.
4. Select the market(s) in which you want to invest.
Index funds can track a certain asset (for example, foreign bonds), industry (for example, technology), or company type (ex. large or mid-sized).
There are S&P 500 index funds that track the performance of the 500 largest companies in the US stock market; total stock market index funds that track a much larger selection of stocks from large, mid-sized, and small companies; international index funds that expose investors to companies abroad; bond index funds that track the performance of a basket of US bonds; and many more.
The funds you select should be based on your overall risk tolerance and other (if any) investments. Stocks are often considered riskier than bonds since they vary more frequently; nevertheless, with higher risk comes the possibility for higher profits.
5. Make sure you know how much money you need to invest.
Most index funds have a minimum investment requirement, which ranges from $1 to $3,000. If you have less money to invest than is required for a certain index fund, you can cross it off your list for the time being.
6. Look for index funds with 0.5 percent expense ratios.
Whether you’re investing in a 401(k), an IRA, or a taxable investment account, look for index funds with an expense ratio of less than 1% – ideally less than 0.5 percent.
The expense ratio is the percentage of your total account balance that you pay the brokerage to handle your investments. It’s automatically removed, so it’s simple to overlook. If you invest in an index fund with a 0.5 percent fee ratio, for example, the brokerage will deduct $5 from your total account balance each year.
Because index funds are supposed to be passive, they don’t require much attention from fund managers (and even less if you employ a robo-advisor). This keeps expenses low.
7. Add money to your account
If you’re using your 401(k) to invest in index funds, you’ll make your choices directly through the 401(k) provider, whether it’s Vanguard, Fidelity, or another brokerage. You won’t have to invest your full amount as well as future contributions in the same account; you’ll be able to pick how you want to distribute it.
If you’re investing through an IRA or brokerage account, you can fund it by transferring money from a checking or savings account. Once the funds have been transferred, they will be held in a holding account until you purchase the index fund.
Investing in an index fund is similar to shopping online. You select the fund, input the amount you want to invest, and then click “purchase.”
8. Make your contributions automated.
If you invest through a 401(k), you’ll already have an automatic contribution set up because it’s a salary deferral, but you’ll have to set it up manually in an IRA or brokerage account. You can choose how frequently the transfers will occur, how much they will cost, and where they will be directed (either into your holding account or directly into the index fund). This can be done online, via your brokerage’s website, or over the phone.