Choosing to invest in index funds is one of the easiest (and best) decisions you can make as an investor. Picking the best index fund is only slightly harder.
There are a few things to look for when picking an index fund. Unfortunately, they are not all created equal, and some are better choices than others.
In fact, there are five things to look for, and we’ll walk through them all thoroughly and quickly so that you can start investing today!
Pick the Right Online Broker
The first step to picking the best index fund is choosing the best online broker.
Some online brokers offer a vast range of low-cost index funds, like Vanguard and Charles Schwab. Others provide a limited number of options at zero cost, like Fidelity. And then some online brokers are way behind in the index investing game that you should avoid.
When choosing your online broker, look for ones that:
- Offer a range of index funds and ETFs across equities and bonds.
- Offer low expense ratios (0.10% or lower).
- Do not charge transaction fees to trade their funds.
- Do not have sneaky, other fees (like load fees).
Charles Schwab and Vanguard both fit the above criteria if you want to skip the research and dive in with an established online broker.
Otherwise, I encourage you to shop around a little. This is an essential first step.
Choose an Investment Strategy
Once you have an online broker, it’s time to choose a strategy.
And I’m not talking an intense day trade strategy or even a dividend portfolio strategy. I’m talking about asking yourself if you want to own one fund, or three.
Choosing an index investing strategy is about as easy as deciding what to watch on TV in the 1960s. And if you weren’t around back then (I certainly wasn’t), I’ll help you out; there were only three channels to choose from – ABC, NBC, and CBS.
So, here are three stable index investing strategies to choose from:
The Single Fund Portfolio
A single fund portfolio is what it sounds like – you own one investment. Usually, this strategy is best for younger, aggressive investors who are okay with putting all their money in an equity broad market index fund.
The 3 Fund Portfolio
A 3 fund portfolio take a slightly more balanced approach and involves investing across:
- US Equities
- International Equities
The amount of capital you put into each segment of the three-fund portfolio is up to you.
The Multi Fund Portfolio
The multi-fund portfolio introduces wildcards to the simple 3 Fund Portfolio above. For example, you can tack on any of the following funds to the mix:
- Small-Cap Equity Funds
- Mid Cap Equity Funds
- Emerging Market Funds
- And many more options
The key is to not stray too far away from what index investing is at its core – owning the whole market.
If you find yourself invested in small-cap biotech stocks, you’ve probably gone too far.
Filter Index Funds for Low Fees
Once you have a strategy, it’s time to find specific index funds to buy. And if you have an excellent online broker, this part is usually pretty straightforward. Just be sure to filter for:
- Low expense ratios.
- $0 in sneaky fees (like load fees).
- And the index that you want to match.
If you want to take it another level deeper, you can also search for:
- Past performance – though if you are choosing the right index to match, then you should already be aware of this.
- Distribution yield – if you are looking for dividend income.
- Portfolio turnover – if you are trying to limit taxes.
- The exact holding of the portfolio – if you really type A!
Buy Your Index Fund(s)!
Now, buy your index funds! Easy.
Most online brokers allow you to transfer money from your bank into your account to make these purchases. Just be sure it’s not a wire transfer, as you’ll likely get charged to make that!
Monitor and Check-In
Last, but certainly not least, you need to check in on your index funds and portfolio at least once a year. But quarterly, or even monthly, is probably not a bad idea.
For one, you should be trying to add money to your portfolio regularly. Investing is not a one and done activity. You should have a consistent savings plan that allows you to invest continually.
And second, you need to rebalance your portfolio to ensure that you are still executing your plan. Of course, if you chose a single fund portfolio, this is not required. But if you are invested in both stocks and bonds, some rebalancing likely needs to occur on occasion. Even if it just happens as you reinvest the money.
Plus, it’s fun to check in on your progress occasionally! Just don’t do it every day…