How To Invest in Index Funds, for Beginners

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Jul. 16 2021, Published 10:33 a.m. ET

There are tons of financial products available to investors of every threshold. Index funds are one of them. What does it take to invest in one of these traditional funds?

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Here are some beginner tips for investing in index funds, considerations to make when choosing a fund, and a few examples of popular options.

But first, what's an index fund?

An index fund is a type of financial product that tracks a particular index.

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The S&P 500 and Dow Jones Industrial Average are two examples of indexes, but the list is extensive. An index can cover a specific area of the securities market. There are also index funds based on unique indices that the fund manager creates.

These funds are meant to mirror the market's performance, not outperform it. This makes an index fund investment reliable, though not extraordinarily lucrative (but it sure beats a high-yield savings account, particularly when federal interest rates are low).

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Things to consider when choosing an index fund

When choosing an index fund, you'll want to consider its asset manager. Are they reputable? Additionally, note what kind of companies the index tracks. The index may focus on capitalization (such as small or large cap), a geographical region (foreign exchange stocks), or a sector or industry (tech or health). You may also find that an index is based on asset type (bonds or commodities) and market opportunities (emerging markets).

Nowadays, investors are also interested in impact investing. Some index funds maintain environmental, social, and governance-compliant benchmarks for issues like climate change, gender diversity, and others. However, you'll never be able to control exactly which companies you're invested in within an index fund.

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Each index fund has fees built into the investment. You'll want to make sure the expense ratio is fair. Typically, you'll see expense ratios between 0.1 and 0.8 percent, with higher fees associated with actively managed funds.

Since your investment in an index fund may trigger purchases and sales of securities, you'll also want to be aware of the tax-cost ratio. If you're investing in an account that isn't tax-advantaged (in the way a retirement account is), the tax-cost ratio tells you how much those taxes will reduce the fund's performance.

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Consider your brokerage before buying index fund shares

Where do you want to invest? You'll want to select a platform that offers convenient trading at a low cost (such as commission-free or no payment for order flow).

Once you choose a broker and you're ready to buy, deposit cash into the account and use it to purchase a specified amount of shares.

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Popular index funds in the U.S. for beginners

Index funds like the Vanguard Total Stock Market (VTSAX) and the Schwab S&P 500 Index Fund (SWPPX) are good beginner options, as they cover a diverse array of public companies.

More niche options include the Fidelity Sustainability Bond Index Fund (FNDSX) for ESG investing, and the Fidelity ZERO Large Cap (FNILX) for companies with large market caps.

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