Index funds are a great investment option if you want to build wealth for the long-term. Even legendary investor Warren Buffet recommends index funds, and for great reasons. Below are some of the reasons why you should opt for index funds and the step-by-step process to invest in it.
Index funds are low-cost investments that come as a total package. It keeps track of a particular financial market and diversifies your funds in order to mitigate the risks. The diversification of your money is one of the many reasons why big-time investors and financial planners recommend investing in index funds.
Basically, index funds are a type of mutual fund that comes as an all-in-one investment. Your funds are diversified across a wide range of stocks or bonds in order to maximize your gains and minimize your losses. Instead of purchasing individual stocks, an index fund is an even better investment, since it entails that you own a small piece of every company or asset you invested in on the index fund. This minimizes your overall risk and keeps your money afloat from a possible one-time heavy loss.
Step-by-Step Instruction to Investing in Index Funds
To begin investing in index funds, you can either begin with a brokerage account, your IRA, or your 401(k). Below will specify your options and optimize the ways you can begin investing in index funds in a safe and efficient way.
Start with your 401(k)
Your retirement plan could be your door to investing, and is often the best place to start it. Instead of viewing your 401(k) as savings, you can choose to invest in an index fund and earn returns. Once you have your 401(k) set up, you get to decide on a deferral rate or contribution percentage taken out of your monthly paycheck and dropped into your investment account. Your employee will offer a selection of safe-bet mutual funds for you to choose from.
Use an IRA as alternative to a 401(k)
If you do not have a 401(k) offered by your company, you can open a traditional or Roth IRA through a bank, broker, or financial institution. Both will provide you access to index funds, despite their differences. Furthermore, you have the option to open an IRA even if you have a 401(k), which is an even more beneficial choice.
Choose a broker account
You also have the option to invest in index funds through non-retirement accounts, also known as taxable investment accounts and brokerage accounts. To get the best investment, you will want to survey different brokerage firms and the index funds they offer. Most brokers display index fund comparison charts for easier accessibility.
Pick an index fund to invest in
Index funds can keep track of the price movements of a specific asset like foreign bonds, a particular industry like tech, and a company-type like corporations. Two examples of this would be the S&P 500 index funds, which is composed of the 500 biggest companies in the U.S. stock market, and total stock market index funds, which keep track of a selection of stocks from small, mid-sized, and large companies. Before you choose, you should consider your risk level and your existing investments. Stocks are viewed to have greater risks than bonds, but they also yield higher potential returns.
Check out the minimum investment amount
Index funds require a minimum investment amount that typically ranges from $1 to $3,000. If you have less funds than the amount required for a specific index fund, you can remove it from your list for now.
Find index funds with expense ratios of 0.5%
You will want to choose index funds with an expense ratio that does not exceed 1%. The ideal range would be 0.5% or lower. The expense ratio pertains to the fee you pay your broker to manage your index fund; it is a percentage of your overall account balance. It is automatically taken out of your account, which can make it easy to miss for some. Still, index funds have low costs since they’re passive investment and do not require a lot of attention from fund managers.
Fund your account
When you invest through your 401(k), you will make your selections through the 401(k) provider. There is no need to invest your entire balance and future contributions in one index fund, and you have the choice to allocate it. When you invest through an IRA or a broker account, you can fund your account through a debit card or bank transfer. Generally, investing in an index fund is as easy as purchasing from an online store. You choose the fund, put in how much you’d like to invest, and click “buy.”
Arrange automatic contributions
If you invest through your 401(k), you have an automatic contribution set up through salary deferral. If you invest through an IRA or a broker account, you will have to set the contributions yourself. You get to decide how much, how often, and where you want your transfers to be directed. You can simply do this online through your phone or your broker.
Once you have completed these steps, you have successfully invested in an index fund. Remember to diversify your investment and assess your risk profile. Invest wisely!