How To Buy an Index Mutual Fund or ETF (Exchange-Traded-Fund)

If You Can't Beat an Index - Mimic It!

Investing in an Index Mutual Fund can be one of the easiest and most profitable investment decisions you ever make in your lifetime. An index is a representation of a section of the stock market. Examples of indexes include the Dow Jones, the S&P 500, the NASDAQ 100, and
the Wilshire 5000.

Interestingly enough, most actively managed mutual funds do not beat the indexes. An actively managed mutual fund is a fund where you have a management team who buys and sells stocks within the mutual fund. As a result of this service, you end up paying larger fees for the management and operating expenses of an actively managed mutual fund. The higher management and operating fees make it very hard for an actively managed mutual fund to beat an Index Mutual Fund. To buy an Index Mutual Fund, or exchange-traded-fund (ETF), follow the following steps.

  1. Purchase through a brokerage account - exchange-traded funds (ETFs) are bought and sold like stocks. Since indexes are bought and sold like stocks, you pay commission on ETFs. Most ETFs trade on the American Stock Exchange. ETFs that track the Dow Jones index are called Diamonds (DIA). Diamonds are a composite of 30 large cap companies. ETFs that track the S&P 500 index are called Spiders (SPY). Spiders represent a broad range of 500 stocks. ETFs that track the Wilshire 5000 can be tracked by investing in Vipers (VTI). Vipers represent big, large and small stocks comprising 5000 stocks in total.
  2. Purchase through a no-load mutual fund. A no-load fund doesn't charge a commission. Vanguard is an example of a no-load fund. Most no-load funds have minimum investments if you purchase them outside of an IRA. Do your research to find out if there is a minimum investment and what it is.
  3. Both mutual fund indexes and ETFs charge an expense ratio.  The expense ratio is where mutual funds and ETFs make their profit, and also where you can lose out as an individual investor. Do not invest in a domestic index fund with an expense ratio greater than 0.40 (that is four-tenths of a percent). Annual fees for domestic ETFs are minuscule, averaging .09% of assets for domestic funds, which is less than one-tenths of a percent. Remember to use a discount brokerage firm to keep purchase costs low.
  4. Make sure you allocate your portfolio. Do not put all your money in one index. Choose a variety of indexes to get exposure to the whole market. Also, consider adding diversity to your portfolio with International indexes. Most of the growth in the next few decades will come from abroad.

Index mutual funds are cost-efficient. Index mutual funds invest in the exact same companies as the index. By doing this, they reduce the operating and management fees that funds charges. These cost savings are passed down to you the shareholder.

 

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