Perhaps you have heard of index funds from a friend, from tv, on a podcast, or even on the internet. However, you may not know exactly what they are or how they can help you with your investing journey. An index fund is a certain type of investment that tracks a market index. These are usually made up of bonds or stocks.
However, just because they’re a form of investing, it doesn’t mean that they’re right for you. Here, you can learn the ins and outs of index funds and whether or not they are the correct type of investment for you.
What are index funds?
Every day, thousands of indexes knowingly track the movements of various sectors, markets, and investment strategies. This is how they determine that specific market’s health and performance properly. The index can also effectively act as a market’s benchmark or its way of measuring its performance.
While you can’t invest directly in an index because of the fact that it is a mathematical construct, you can invest in an index fund. You can do this either through an ETF or an index mutual fund. Index funds are passively managed.
This means that they maximize returns and minimize costs by holding what is in the index, which rarely changes. Here are the pros and cons of index funds:
- Lower costs-
- Performance you can depend on
- Difference in management
- Lack of flexibility
- Tracking error
- Rarely outperforms the index
How do I choose an index fund?
There are thousands of different indexes you will be able to track using index funds. Before deciding on an index fund, research is highly important, but you also need to evaluate a few important factors. These factors are:
- Timing– Decide when you will need the money and how soon you will need it
- Risk tolerance– You will need to understand how much risk you are willing to take on for the return that is anticipated. You will also need to understand the risks that are associated and if this fund fits well into your investment strategy, financial goals, and plan.
- Fees– You will need to figure out exactly how much you will be paying for buying, owning, and even selling the fund. To compare costs, you should compare funds that cover the same sector.
Once you have chosen a specific index you will most likely be able to find, at the minimum, at least one index fund that tracks it. Sometimes, you may even have a dozen or even more choices that all track the same index, so most of the time you aren’t limited to just one choice.
If you have many index fund options, it is essential to first do your research and know some basic things that can efficiently aid you in your investing journey. You should be prepared to ask some basic questions such as:
- Which index fund has the lowest fees?
- Which index funds track the performance of the index more closely?
- Are there any specific restrictions or limitations on an index fund that will prevent you from investing?
- Are you interested in other index funds provided by that index fund provider?
The answers to all of those questions will be able to efficiently guide you in the right direction when you are choosing the best possible index fund for you. When it comes to investing in the index fund, you should be able to open a direct account with the mutual fund company that offers the index fund.
If not, you will easily be able to open a brokerage account with a broker. That will allow you to buy/sell shares of the index fund that you are interested in. It always pays to look at the costs and features when deciding which route is best for you when buying shares of your index fund. It can sometimes be cheaper to go straight through the index fund company to open an account as some brokers will charge inflated fees to invest in index funds.
Investing in index funds really is one of the easiest, user-friendly, and rewarding ways to build your wealth and reach all of your important financial goals. Index funds can quickly and easily turn your investment into a nest of financial wealth, and the best bit is, you don’t have to be an expert investor to do it!
Index funds are a great way to start, and later on, you can even start to build your portfolio and look at investing in other things such as stocks and real estate! Investing in stocks is made substantially easier with The Motley Fool, as you will receive only the best advice available to new investors. For real estate investing, look no further than Fundrise, a real estate crowdfunding platform that makes it simple to invest in real estate.