Investing In Index Funds : What is an Index Fund ... List of top 5 Index Funds

What Are Index Funds

An index fund is a group of bonds, stocks and other types of securities that are used in tracking market index. Market index denotes a compilation of securities representing a part or segment of the market. An index fund can also be defined as mutual funds or exchange-traded funds (ETFs) with a portfolio reflecting a specific market index focusing on matching its performance. A good example is the stock market index. A stock market index owns shares of component stocks representing a specific index being tracked. An investor or a stock investor only owns some specific proportion of the stock.

Index funds are not limited to stock alone, there are a lot of index funds in the business world today. Virtually all imaginable market investments have an index fund. We have index funds for market investments such as commodities, bonds, real estates and so on. The stock index could own just a small quantity of stocks while others could own hundreds or thousands of varying stocks. The main focus is not on the number of stocks being owned and the index being tracked, the main goal of an index fund is the match of the performance of the underlying index. The difference in the index funds depends on the index that is being tracked. The index can be created by either the fund manager or other companies like the brokerage or the investment bank. 

The most popular index that is often tracked is the S&P 500. This is simply a collection of 500 biggest companies in the United States. S&P 500 is advisable for one who is just beginning to build his or her portfolio. An easier method for this is to buy one of the shares in an index fund and allow the share to do the tracking.  This principle can be used for index funds like international stock, US stocks, bonds, and real estate and so on.

Advantages Of Investing In An Index Fund

Index fund imitates the way index works. This implies that the securities would be invested in the same way they are presented in the index market. 

• The most obvious advantage of investing in index funds is that its total return is generally higher than other forms of investment.

• Another advantage of investing in an index fund is, they are generally passive in nature. This simply means the fund manager does not continue to buy and sell index funds in other to beat the market. Rather, the index fund remains in the market by just duplicating its designated index.

• Also, when a stock in an index fund does not perform very well, others would cover up for it. This means, by investing in just one index fund, you earn assess to invest in all American's biggest companies. This added advantage of broad diversification helps lower overall risk 

• However, unlike the index fund, in an actively managed fund, the money manager invests in a fund based on their own discretion. This is usually a very difficult work and one of the major reasons index funds are better.

• Also unlike actively managed fund, an index fund does not require doing any analysis to beat the market. All the investor does is to invest in the index fund and it simply follows the market.

• Index funds do not charge additional fees like manager fees, admin costs, and others. As a result, they are relatively low-cost. For instance, an average index fund cost 0.20% while an average actively managed fund cost 0.60%.

• In terms of tax, index fund allows the fund manager to trade in and out of securities. This helps reduce the tax on income.

• Another advantage of index funds in terms of tax is that an investor that often buys new lots of securities would have a lot of options to choose from when selling any of his or her security. As a result, the fund manager has the option to sell the lot with the lowest tax bite 

These few advantages show that investing in index funds is the best form of investment. Warren Buffet, one of the popular billionaire investors in the United States said “When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.”

Five Best Performing Index Fund

The five index funds that would be examined in this section are all S&P 500 index funds selected from a group of companies. They are also some of the lowest-cost funds in the index market. The index fund listed below includes three ETFs and two mutual funds.

1. Fidelity ZERO Large Cap Index
2. SPDR S&P 500 ETF Trust
3. Vanguard S&P 500 ETF
4. Schwab S&P 500 Index Fund
5. iShares Core S&P 500 ETF

• Fidelity ZERO Large Cap Index

This is one of the investment company's foray into a mutual fund. From the description of the fund, it does not involve any expense on ratio, hence it is zero monikers. Technically, the fund follows the Fidelity US large index and does not officially track the S&P 500. The difference between its method of tracking index is academic. This implies that the Fidelity does not have to pay some exorbitant fee to be qualified to use the S&P name. This made it generally affordable for investors.

The expense ratio for Fidelity ZERO Large Cap Index is zero percent, hence for every manual investment of $10,000, the expense ratio is $0.

• SPDR S&P 500 ETF Trust

This is one of the longest ETFs as it was founded as far back as 1993. The index fund played a significant role in the popularity of ETFs today. SPDR S&P 500 ETF is sponsored by State Street Global Advisors and it tracks the S&P 500 index. As of Dec 2019, the index fund ranked as one of the most popular with $302 billion in asset.

The expense ratio for SPDR S&P 500 ETF Trust is 0.09. This implies that for every $10,000 manual investment saving, the expense ratio is $9.

• Vanguard S&P 500 ETF

As suggested by the description, this index fund tracks the S&P index. The ETFs gets into the business of index fund in 2010 and is sponsored by Vanguard. In Dec 2019, it ranked one of the largest index markets with an asset worth $520 billion.

The expense ratio for Vanguard S&P 500 ETF is 0.03 percent. This implies for every annual investment of $10,000, the expense ratio is $3.

• Schwab S&P 500 Index Fund

Schwab S&P 500 Index Fund is best known for its investors-friendly products as portrayed in their low expense-ratio. The mutual fund has been in existence as far back as 1997. It is sponsored by one of the recognized names in the industry Charles Schwab. In Dec 2019, the industry is worth $46 billion in assets.

The expense ratio for Schwab S&P 500 Index Fund is 0.02 percent. This means that for every $10,000 annual investment, the expense ratio is $2.

• iShares Core S&P 500 ETF

iShares Core S&P 500 ETF was introduced in 2000 and among the largest ETFs. It also tracks the S&P 500 and us sponsored by one of the significant companies in the industry - Black Rock. As at Dec 2019, it has $200 billion in assets 

The expense ratio for this index fund is $0.04, this implies that with an investment of $10,000 annually, the total expense ratio would be $4.

How to invest in an Index fund

• 401(k) account

The best place to start investing in index funds is through your 401(k) retirement savings account. Usually, people regard the 401(k) account as strictly a savings account however, saving part of your salary in the account is only the beginning of choosing where to start your investment.

With your 401(k) account, all you need to do to start your investment is to decide on deferral or rate that would be separated strictly for your index fund. After this, you contribute this money to a fund investment account in brokerage companies such as Vanguard, Fidelity, or Charles Schwab. Most times, your company gives you a selection of index funds you can invest in.

• Use an IRA if you don't have a 401(k)

This is the simplest way out if you don't have a 401(k) account. If you don't have a 401(k) account, you can easily open a traditional or Roth IRA through a bank, brokerage firm or any financial firm of your choice. The only difference between the two is only in terms of tax. However, both of them will give you access to an index fund account.

• You can choose to open a brokerage account.

You can choose to start your investment through a non-retirement account like brokerage or other financial institutions. The only differences between a retirement account and a non-retirement account are that a brokerage account is taxable. 

Among the most popular brokerage account, we have Fidelity, Charles Schwab, Vanguard and E*Trade. Depending on your choice, any of these accounts can be opened through Robo-advisors like Betterment, Wealthfront, or Ellevest. With Robo-advisors you can start your investment minutes after opening the account. 

• Choose a market you want to invest in

The most important aspect of consideration when choosing a fund is the overall risk and the total money involved. Basically, bonds are less risky when compared to stock. However, the distinctive feature of a stock is that the higher the risk involved, the more potential for a greater return.

• Take note of the minimum investment amount.

This simply means that you take into consideration the cost of fund especially when you have low cash to invest. Generally, in an index fund, an investment fee is often within the range of $1 to $3,000

• Choose index fund with expense ratio not more than $0.5%

The expense ratio is calculated as a percentage of your total account balance and deducted as a fee you pay to the brokerage for managing your investment. The money is deducted automatically and can be easily missed. For instance, if the expense for your investment is 0.5%, for every $1000 paid annually, the brokerage will deduct $5. 

Generally, the expense ratio is very low on index funds. This is because index funds are designed to be passive and do not require any watch from the fund manager or any analysis from any analyst. In fact, the fee tends to be lesser when using a Robo-advisor.

•  Fund your account

Selections of investment are usually very direct in a 401(k) plan, hence if you are planning to invest through your 401(k), you can make your investment selections directly. 

However, if you are using a brokerage or an IRA account, you can easily connect your index fund account to a saving or a current accountant then transfer the money. When the money is transferred it remains in a holiday account until you invest in an index fund.

To make your investment, you simply choose the fund you want to invest in, enter the amount you want to use for you'd investment and click on buy. This is very similar to online purchase 

• Set up automatic contributions

If you are using a 401(k) account, your contribution has been automated since you are paying through salary deferral. However, if you are using a brokerage or an IRA, you would have to select the money you would want to invest in. You would also decide how many times in a month or year you want to invest. This can be carried out through the brokerage website.

Always take note of the total return from index fund before taking a decision on the index fund to choose from.