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August 29, 2019

Investing in Index Funds

If you agree that life is unpredictable, the chances are that you might have gone through many challenging circumstances. With that in mind, many people take important financial decisions to ensure a secure future. And investing in funds is one way to do that when it comes to stabilizing your financial condition.

Index funds, in this regard, have become one of the major forces in the investment world. In fact, according to a recent survey, every $1 out of $5 in the United States is invested via the conduit of an index fund.

What does investing in index funds mean? How does it work?  And what are its benefits and drawbacks? These are the most important questions you need to ask when you are considering investing in index funds. If you are a beginner or small level investor, it is important to understand the basics of investing in mutual funds.

What Are Index Funds?

Index funds are a type of mutual fund. They have a constructed portfolio to track financial components of index market such as S&P 500 indexes. These funds provide investors exposure to a broad market. Regardless of the state of the market, index mutual funds follow their target index.

In general, index funds make perfect portfolio holdings, especially for retiree accounts such as 401s and IRAs. Many expert investors such as Warren Buffet recommend index funds to people for their retirement age for good savings. In addition to that, these funds are considered better investment than individual stocks.

 

Types of Index Funds

One of the interesting features of index funds is that the cheaper you buy them, the best the result will be. It is because they essentially track the benchmark index. Since both expensive and cheap funds have the same goal, buying expensive index funds has no point.

To help you make the best choice, we have compiled a list of the cheapest index mutual funds.

S&P 500 Index Funds

These specific funds track the S&P 500 index that comprises 500 American large stock companies according to market capitalization.

 These are the two cheapest index funds tracking the S&P 500:

  • Fidelity 500 Index: The funds do not have a limit for minimum investment and they have a 0.02% expense ratio.
  • Schwab S&P 500 Index: The funds have 0.02% of expense ratio or $2 for $10,000 invested. Like the fidelity index, they also do not have any minimum limit for an initial investment.

The average expense ratio of mutual funds is typically ten times higher than these expenses. As compared to that, these expenses are very low. Also, if you compare the index funds to the expense ratio of the famous Vanguard 500 Index, you will find the above incredibly pocket-friendly.

Large Growth Stock Index Funds

Using market capitalization, large growth index funds invest in the largest American growth stock company. The funds track the Nasdaq-100 and Russell 1000 Growth index. As a result, an investor gets many stocks that are the same as those in the S&P 500 index. However, they are all growth stocks. Although the growth stocks are beneficial, they tend to have high relative risk and are more aggressive than other stocks. They do have high potential when it comes to long-term returns.

 The two cheapest index funds that track large-cap growth US stock index are;

  • Fidelity NASDAQ Composite Index: With 0.3% expense ratio, it has no minimum investment limit.
  • Vanguard Growth Index: It has 0.17% expense ratio or $17 for $10,000 investment. Unlike the previous index fund type, it has an initial investment limit of $3,000.

These index fund types are top-rated because an investor gets high quality at a low cost with them.

Large Value Stock Index Funds

These stocks index funds are often under-appreciated in the stock market. Therefore, they are sold at a discount. Value funds stocks are considered value funds as they pay dividends. The value stocks index funds track both the S&P 500 and Russell 1000 index. Here are the two types;

  • Vanguard Value Index:  It has a 0.17% expense ratio and $3,000 minimum initial investment.
  • Vanguard High Dividend Yield Index: It has a 0.15% expense ratio and $3,000 minimum initial investments.

Pros & Cons of Investing in Index Funds

Index funds are primarily designed to track and match the results of investment of any market index. If you know their pros and cons, it may help you seek the improved market returns aligned with your financial needs.

Benefits

  • One of the core advantages of index funds is that they make a low-risk option for beginners to invest in bonds and stocks.
  • They are some of the actively managed mutual funds.
  • They mimic the performance and composition of the financial index market.
  • They are suitable as a passive strategy to invest money.

Risks

  • Not all Index funds have the potential to track the market as other managed funds do. That means when an investor invests in index funds, he/she surrenders the possibility of a massive gain.
  • Fund managers are bound to follow the strategies and policies to perform with the index market. This may result in a lack of options to limit the losses if returns are declining.

Investment in Index Funds – FAQs

  • How are index funds different from an actively managed fund?

Index funds match the performance of the specific market benchmark closely. Actively managed funds, on the other hand, attempt to outperform the benchmarks. Index funds are more tax-efficient than actively managed funds.

  • How important is it to focus on independent funds rating?

An independent funds rating is an easy way to compare funds. However, remember that their rating is based on the past performance of the funds. It is important to match your investment objectives with funds rating.

  • How do I make money by investing in index funds?

As an investor, you can earn income through capital gains from the funds that are shared at a price that’s higher than what you paid at the time of buying them.

Key Takeaway

Overall, index funds are an easy, convenient and low-cost way to invest in the stock market. They can provide a well-rounded selection of stocks in a single package.