How To Invest in Index Mutual Funds

Investing in index mutual funds is a great way to save for retirement and other long-term goals. An index fund is a mutual fund set up to track a stock market index, such as the S&P 500 or the NASDAQ. Index funds invest in hundreds or thousands of different companies to match the composition of a specific stock market index. This provides two benefits for the individual investor: diversification and low costs. You get a simple, diversified investment because the fund invests in a wide variety of companies, and you get a low-cost investment because there are no fund managers actively picking stocks. Here is how you can invest in index mutual funds.

Choose a brokerage

Your choice of brokerage partially defines what index funds are available to you. The major brokerages for investing in index mutual funds are Vanguard, Fidelity, and Schwab. Each has their own suite of funds. Vanguard has the largest assortment of index funds, Fidelity has the lowest fund costs, and Schwab has the lowest account balance minimums. Your selection depends on your individual needs as an investor, and the funds you want to purchase.

Open an account

Once you have selected a brokerage, you need to open an account. The most common options will be to open an IRA for tax-deferred contributions, a Roth IRA for tax-free retirement savings, or a taxable account for other saving goals. Your choice will depend on your individual investing goals. Once you have chosen a brokerage and opened an account, you will need to provide them with the routing information for a bank account to pay for your investments.

Select your funds

Once your account is open, you need to select your index mutual funds based on your investment needs. You can research the funds at each brokerage's website, or through third party services like Morningstar, Yahoo! Finance, and Google Finance. Important details for selecting an index mutual fund are the expense ratio, which shows you how much the fund charges to invest in it, and the indexes that each fund tracks. If two funds track the same index, you should purchase the one with the lowest expense ratio, since both funds invest in exactly the same stocks. You should select indexes that match your risk tolerance; stock funds will be more volatile than bond funds, and international stock funds carry different risks from US funds, such as currency risks and possible tax ramifications.