This blog is designed to help new investors learn how to invest in index funds. It follows on from the Beginners Guide to Index Funds and covers:
- How to buy an index fund
- Which Index Funds should you invest in?
- 8 things to look out for when buying an Index Fund
- How to build an index fund portfolio for beginners
How to buy an index fund
Buying an index fund is incredibly simple. Most investment platforms will offer index funds for you to invest in.
Simply set up an account, deposit and pick the fund or funds you want to buy.
When buying shares in an index fund you are buying directly from the fund itself. It is different to individual stocks which you effectively buy off another individual. As a result, index funds only trade once a day rather than through out the day like individual stocks. Any purchases will not go through until the end of the day’s trading.
Which index funds should you buy?
Index funds cover many different asset classes from stocks to bonds and commodities. Which index you should buy all depends on your investment strategy.
One of the best places to start buying Index funds is through Vanguard. Vanguard has a good selection of funds, and the company is one of the most trusted and offers some of best value funds in the industry.
8 things to look out for when investing in an index fund
Index Funds are all remarkably similar but there are some subtle differences. You need to make sure you choose the one with the right elements for you.
Tracking the right index – there are many different indexes so double check the fund is tracking the index you are looking for.
Currency – index funds can be in different currencies so check it is in the right currency for you. For example, you may not want to invest in an American fund based in dollars and subject yourself to additional currency risk and costs.
Accumulation vs Income – funds are set up to either reinvest any dividends or pay them out. Make sure you choose the right one for you.
Costs – charges can vary greatly by provider and investment costs can materially impact your long terms returns. VANGUARD FTSE 100 INDEX ACCUMULATION (GBP) costs 0.06% whereas HSBC FTSE 100 INDEX CLASS C – ACCUMULATION (GBP) costs 0.09%. It may not be much, but it all counts to increasing your returns over the long run.
All this information in held in the Key Investor Information Document (KIID). All funds must make the KIID readily available, so they are not difficult to find.
Compliant for your country – frustratingly not all products are available in all countries. Some American funds are not available in Europe.
The fund size – this is important because the smaller a fund is the more chance of it being closed or merged with another fund. Anything over £250 million should be okay.
Tracking error – all funds must report how closely they have copied the index. By checking the tracking error, you can see how effectively the funds have tracked the index. Avoid funds with large tracking errors.
The index make up – always check to see what is in each index so you know what you are investing in. You will easily be able to see the top 10 holdings, so you know where most of your money is invested. You can also check the index does not have any assets you are uncomfortable investing in.
All funds have a Fact Sheet in addition to the KIID document with all the relevant information about the fund. Make sure you read both.
How to build an index fund portfolio for beginners
You can pick just one index or a mix of index funds. However, the best method for new investors is to invest in ready-made portfolios which are usually made up of index funds.
You set up an account with a broker, deposit, choose the ready-made portfolio you want to invest in, and press go.
If you want to learn how to build your own portfolio of different index funds read The Gone Fishin’ Portfolio.
How to invest in index funds summary
It is extremely easy to invest in index funds. Make sure you go through the check list above to ensure you are picking the right funds for you.
There are some simple things to double check like the country compliance, the index and its holdings to ensure you have the right product and know what you are investing in.
Then, there are few more important things to check like the costs, currency and dividend payments to ensure you are getting the right value.
Finally, the more subtle things to check like fund size and tracking error will ensure you choose a well-run fund.
To see which index funds, I have invested in you can see my holdings in my eToro portfolio.
How in invest in index funds FAQs
Can you lose all your money in an index fund?
You are very unlikely to lose all your money in an index funds. As you own all the companies or assets in an index you have a lot of protection and benefit from diversification. For example, if you own a FTSE100 index fund you own all 100 companies listed on FTSE100. It is very unlikely they will all go bankrupt. There is more risk that the provider you use will go bankrupt. Make sure you are using an FCA regulated investment platform and double check the size of the fund you invest in.
Which Index funds have the highest returns?
You cannot predict which index funds will have the best performance. Historically the S&P500 which follows the top 500 companies in America has provided good returns. $1 invested in the US stock market in 1900 grew to $43,650 by 2015.
Do index funds pay dividends?
Most index funds pay dividends. For example, a FTSE100 index funds with HSBC pays approx. 3%. You can choose to either have your dividends paid out or automatically reinvested.
What is the best index fund?
That depends on your goals, attitude to risk and investment strategy. If you are risk adverse and looking for a low risk return you may be better off investing in index funds that specialise in bonds. If you have a long investment time horizon and are not worried about volatility, an S&P500 Index Fund might suit you better. Vanguard is one of the most trustworthy in the industry and a good place to start.
Where can I find an index fund list?
You should be able to find a list on most investment platforms. Alternatively, Morningstar is an excellent source of information.
How much does an index fund cost?
One of the benefits of index funds is they can be a relatively cheap way to invest. Prices start from as little as 0.06%. You will also have to also pay any relevant investment platform management fees.
Is it better to buy stocks than index funds?
Buying individual stocks takes a lot of time, knowledge and effort. Some individual stocks can outperform the index average. For most new investors index funds are an excellent way to investing.