What is an Index Fund?

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Investors have a lot of choices. Should you invest in Microsoft, Tesla, Home Depot – which is the best stock? If you’re indecisive and don’t have time to flip through each company’s history, projections and product pipelines, there’s another way to invest: index funds.

But don’t take my word for it. Warren Buffett has said that the S&P 500 index fund is the “best thing” for most people.

What is an Index Fund?

An index fund is a simple, smart way to invest in stocks or certain industries depending on the fund that you choose. Instead of trying to decide between hundreds of stocks, an index fund allows you to invest in an entire market index.

For example, you can invest in the S&P 500 market index.

The fund is passively managed, offers low fees and generates high returns. You purchase stock in an index fund that is comprised of stocks in a certain market index. The S&P 500, for example, has some of the world’s top-performing companies and stocks:

  • Apple Inc.
  • Microsoft Corp.
  • Amazon.com Inc.
  • Facebook Inc.
  • Alphabet Inc. Class A Shares
  • Berkshire Hathaway Inc.
  • Johnson & Johnson

When you invest in a fund, you’ll benefit from steady returns and less volatility. Earning reports are a time when investors sit down and clamor to see how a company’s revenues for the quarter panned out.

If expectations for iPhone sales weren’t met, the stock declines and your investment suffers. Since multiple stocks are in an index fund, they balance each other out, allowing for far more stability in your portfolio.

Choose the Right Index Fund

The S&P 500 index fund is one of the most common because it includes large, well-known companies in a range of industries. There are more index funds that you can invest in to diversify your portfolio, including:

  • Small-cap indexes
  • Medium-cap indexes
  • Large-cap indexes
  • Foreign exchanges
  • Industry or sector
  • Bonds, commodities or cash
  • Emerging markets

One of the main selling points of an index fund is that they’re low cost in terms of fees, although some funds are relatively cheap to invest in. You should pay attention to the investment and account minimum and expense ratio when adding index funds to your portfolio.

Expense ratios can vary greatly from one fund to the next, even if they encompass the same market index.

Vanguard’s 500 Index Fund Admiral Shares is one of the most popular index funds. It has a $3,000 minimum investment and expense ratios of 0.04%. Schwab’s S&P 500 Index Fund has no minimum and expenses of 0.02%.

You’ll want to track performance of the fund you plan on adding to your investment portfolio to see what types of returns investors enjoyed in the past. Since the fund mirrors the underlying index’s performance, it’s a relatively low-risk form of investing perfect for beginners and advanced investors alike.

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