how to invest in index funds

The most passive approach to accumulating appreciating assets is long-term investing in index funds.

Index funds come in the form of mutual funds and ETF’s. 

They are a combination of many stocks brought together to mimic specific indexes, such as the S&P 500 or the Russell 2000, meaning they should grow roughly in line with that index. 

Index funds are very popular in that Warren Buffett gave the advice to investors to stick with index funds. 

Index funds are also very popular with the FIRE (Financially Independent Retire Early) movement. 

Holding an index fund in your investment portfolio creates diversity instantly. When you buy a fund that mimics an entire index like the S&P 500, diversity is built in.

Mutual funds include index funds, but not all mutual funds are index funds. Mutual funds can also target specific industries or companies. 

For example, there are mutual funds that only consist of technology companies or energy companies. There are mutual funds that only include growth companies. 

Mutual funds are professionally managed. The downside is that there is a fee associated with many mutual funds because of this professional management, which is identified in the expense ratio.

Make sure you look for low-cost mutual funds with historical good rates of return (usually above 10%). 

If you’ve opened your account with a large discount broker, you can go to their website and search for mutual funds to look at their historic return over the last 5, 10, and 20 years. 

Most brokerages show each mutual fund’s ratings as well as the historical returns and the expense ratios. The lower the expense ratio, the less fees there are associated with the fund. Spend some time comparing the different funds. You’ll learn a lot.

Also, note the turnover ratio.  A higher turnover ratio means the stocks within the fund change more often, generally resulting in higher tax impacts each year.

The other thing to know about mutual funds is when you sell them, you aren’t able to sell them until the end of the trading day. You can put in your sell request at any time while the market is open, but you won’t know the price that you’re selling it at until the close of that trading day. It took me a while to understand this, but it’s generally not that big of a deal, especially if you don’t plan to sell very often.

ETF’s (exchange traded funds) are very similar to mutual funds in that they are baskets of stocks from multiple companies in the same industry or within similar phases of their life cycles. 

The primary difference with ETF’s is that they aren’t managed like the mutual funds. They can be bought and sold at any time while the market is open. In other words, if you want to sell some of your shares at 1pm, then you can sell them at 1pm.  You will get an immediate confirmation instead of having to wait until the end of the trading day. 

ETF’s also generally have lower expense ratios because they are not professionally managed, but not always.

Any of the above choices are great options for consistently investing over time.

If you are planning to retire early and are not sure where to start, contributing to an index fund is your best option. Based on history, the major indexes have grown over time. Yes, there have been some dips along the way, but look at the trends when you do your research. Their overwhelming trajectory is up.