The case for index investing is easy to grasp: Mutual funds and exchange-traded funds ETFs that simply aim to replicate the performance of major indexes tend to deliver better long-term performance than actively managed funds with a similar focus, at a fraction of the cost. Yet choosing the right fund can be challenging, especially given the rapidly multiplying number of options available.
In a recent report, Morningstar identified nearly large-cap blend funds that could provide the foundation of a well-diversified portfolio. So, how do you choose the best one for you? The majority of index funds and ETFs charge an annual fee called an expense ratio. This small fee covers the operating expenses for a fund. Yes, even though index funds simply seek to emulate the performance and composition of existing indexes, there are still costs associated with buying and selling the investments they hold, among other things.
Those uber low expense ratios may work out better for you than similar funds charging higher fees over time. Check out the math. If the expense ratio for another fund tracking the same index pursuing the same strategy was only 0. Now imagine how that can multiply over the course of a or year investment timeline. Practically speaking, what separates an index fund from an ETF really comes down to how frequently the share price of the fund changes.
With an index mutual fund, you can place an order at any time, but the price of your purchase or sale will be based on the value of all the underlying securities at the close of the current trading day. If you place an order after the market has closed 4 p. ET for U. An ETF trades just like a stock, and its price changes throughout the trading day. But if you open an account at a brokerage you can get rolling with an initial investment of just one ETF share, which is typically going to be a lot less than a fund minimum.
You may even be able to get started purchasing just a fractional share of an ETF. Moreover, ETFs often have an expense ratio advantage. Once you've chosen an index, you can generally find at least one index fund that tracks it. If you have more than one index fund option for your chosen index, you'll want to ask some basic questions.
First, which index fund most closely tracks the performance of the index? Second, which index fund has the lowest costs? Third, are there any limitations or restrictions on an index fund that prevent you from investing in it? And finally, does the fund provider have other index funds that you're also interested in using?
The answers to those questions should make it easier to pick the right index fund for you. To buy shares in your chosen index fund, you can typically open an account directly with the mutual fund company that offers the fund.
Alternatively, you can open a brokerage account with a broker that allows you to buy and sell shares of the index fund you're interested in. Again, in deciding which way is best for you to buy shares of your index fund, it pays to look at costs and features. Some brokers charge extra for their customers to buy index fund shares, making it cheaper to go directly through the index fund company to open a fund account. Yet many investors prefer to have all their investments held in a single brokerage account.
If you anticipate investing in several different index funds offered by different fund managers, then the brokerage option can be your best way to combine all your investments under a single account. Investing in index funds is one of the easiest and most effective ways for investors to build wealth. By simply matching the impressive performance of the financial markets over time, index funds can turn your investment into a huge nest egg in the long run -- and best of all, you don't have to become a stock market expert to do it.
As simple and easy as index funds are, they're not for everyone. Some of the downsides of investing in index funds include the following:. To address some of these shortcomings, you can always keep a mix of index funds and other investments to give you greater flexibility. If you plan on solely using index funds, however, you'll have to get comfortable with their limitations.
For more on your other investment options: How to Invest Your Money. Owning shares of individual companies can be especially rewarding, but you'll need to do some research. ETFs are collections of stocks that trade just like a stock, bought and sold throughout the day with fluctuating prices. Properly planning for retirement could be the most important investment decision of your life.
Start here. If you're looking for some index fund ideas to help you invest better, the following four are a good place to start. Once you've decided which index you're interested in, it's time to choose which corresponding index fund to buy. Oftentimes, this boils down to cost. Low costs are one of the biggest selling points of index funds. Check out our top picks for robo-advisors. Those fractions of a percentage point may seem like no big deal, but your long-term investment returns can take a massive hit from the smallest fee inflation.
Typically, the bigger the fund, the lower the fees. Investment minimum. The minimum required to invest in a mutual fund can run as high as a few thousand dollars. Account minimum. This is different than the investment minimum.
Expense ratio. For context, the average annual expense ratio was 0. Tax-cost ratio. In addition to paying fees, owning the fund may trigger capital gains taxes if held outside tax-advantaged accounts like a k or an IRA. Like the expense ratio, these taxes can take a bite out of investment returns: typically 0. You can purchase an index fund directly from a mutual fund company or a brokerage.
Same goes for exchange-traded funds ETFs , which are like mini mutual funds that trade like stocks throughout the day more on these below. See our picks for best brokers for mutual funds. When you're choosing where to buy an index fund, consider:.
Fund selection. Do you want to purchase index funds from various fund families? Find a single provider who can accommodate all your needs. But if you require sophisticated stock research and screening tools, a discount broker that also sells the index funds you want may be better.
If you don't have a brokerage account, here's how to open one. Trading costs. Impact investing. Many k plans, unfortunately, do not offer index funds this cheap. This may be true if your plan provider is an insurance company or brokerage firm offering its own proprietary funds.
While the advice to focus on index funds in your k plan is often sound, make sure that you look at the index funds offered in your plan to ensure that you are making the best choices. For k participants fortunate enough to have a selection of several low-cost index funds, the advantage over higher-cost active funds can be significant. There is a wide range of low-cost index mutual funds and ETFs covering widely used indexes across the nine domestic Morningstar style boxes , as well as widely used foreign stock indexes.
The same holds true on the fixed income side of things. While back-testing is a valid analytical tool, investors need to be careful about ETFs using indexes that consist of a large amount of back-tested historical results. There are few to no known rules governing the underlying assumptions used in applying this data and the simulated results may not be an accurate portrayal of the risks of ETF.
Investors in index products tracking real estate in the form of a real estate investment trust REIT or emerging market stocks suffered large losses as well. Index fund investors do, however, eliminate manager risk. This is the risk of an active manager underperforming the benchmark associated with their investment style due to the investment choices they make in managing the fund. This was done in large part to maintain Vanguard's status as one of the lowest cost index fund shops.
While not impacting most buy-and-hold investors, one should stay on top of their funds' holdings for changes like this, as mutual fund providers continue to compete on price. Just investing in an index fund or two doesn't mean that you're on your way towards achieving your investment or financial planning goals. Index funds are tools just like any other investment product. In order to gain the most benefit from using index funds either exclusively or in combination with active funds, you need to have a strategy.
Index funds work quite well as part of an asset allocation plan. Index funds at least the ones tracking basic core benchmarks offer purity within their investment styles. Investing in index mutual funds and ETFs can be an excellent low-cost strategy for all or a part of your investment portfolio.
Like any other investment strategy, investing in index funds requires that you understand what you are investing in.
0コメント