How To Invest In Low Cost Index Funds

How to start investing in low cost index funds

Previously we outlined how to begin investing with 5 actionable steps. Begin with this article if you do not currently have an investing account. After reading that article and setting up an account, then you may proceed to the information below.

After choosing the type of account that you would like to transfer your savings into, you have some options once the money arrives for what you would like to invest in. You could try to pick individual stocks and become the next Warren Buffet, but I strongly encourage you to avoid this temptation. Rather, I like to keep 90% of my money exposed to a broad array of stocks which typically earn 8-10% per year over the last 200 plus years. How do I do this? Low cost index fund investing.

The choice is yours. Consult a financial advisor immediately if you are not willing to embark on this journey alone and accept the full responsibility of managing your own money. For those so inclined, managing your own money has the ability to yield superior results, if you are willing to become an expert in personal finance along the way (yet another reason to start reading).

My favorite companies to open investing accounts with are Vanguard and Fidelity. They offer some of the lowest cost index funds that give you the opportunity to participate in years and years of compound interest, without all the added fees that active mutual funds typically carry.

Be advised, not all companies will offer top notch low cost index funds. Often times, especially in 401(k) and 403(b) plans, your options will be very limited. I believe that you can still find good low cost options that expose you to a broad array of stock ownership by following some simple tips outlined below.

How To Find Good Index Funds Regardless of What Company Your Investment Account Is With

When considering index fund investing, here is primarily what you are looking for.

1. The fund should track a major index

• For those seeking investing in stocks:
  • Seek and index that tracks the S&P 500 or a Total Market
• If you are looking for bonds, it seems most folks choose funds that track a bond index such as:
  • Bloomberg Barclays U.S. Aggregate Bond Index or Intermediate to Long-term bonds
  • Municipal Bond funds

2. The fund should be low cost

• ​Total expense ratio less than 0.1%, in our opinion
• If there is a fund manager, they should have little to no expenses
• The fund should be passively managed, NOT actively managed
  • ​This will help keep fees down. Besides, active funds typically always have lower returns over the long run than passive funds
  • If it is not listed in the description of the fund whether it is active vs. passive, look at the turnover rate of the fund.
    • High turnover = active management
    • Low turnover = passive management

3. Beware of ANY and ALL annual account fees (especially those of you saving in a 403(b) or 457 plans)

• These fees are for the account itself, not for the fund you are investing in
• Look for administrative fees, annual account fees, and advisor fees that may not be listed in places that are easy to find. In the past, we have had to dig for these! Several calls, several emails, several meetings later we finally found our answers. Trust me however, it is all worth it because it means more money in your pocket to invest!
  • ​Sometimes you even have to ask "Are there any other charges or expenses, either one-time or recurring, associated with owning this account?"

Choosing Fund Types

When index investing, you have as few different options into what types of funds to choose from.

You can invest in exchange traded funds (ETFs) that trade in real-time like other individual stocks. Or you may choose a index mutual fund which typically trades once per day at the closing price. Either one is a great choice as long as you keep the expense ratio under 0.1%. Vanguard and Fidelity have great index mutual fund options and iShares, as well as Fidelity, have some great ETFs.

There are additional options for those who wish to further diversify such as small cap and mid cap index funds which place greater emphasis on smaller and medium sized companies. My personal preference is to stay with large cap which is what an S&P 500 index will offer. If you were to choose an ETF or an index mutual fund that tracks the Total Market, you will inherently diversify into small cap and mid cap companies as well since it carries large, medium, and small companies in it's portfolio.

Speak with you financial professional regarding the above options when investing. If choosing to DIY, check out my resources page for books on how I learned to start investing without needing to pay a financial advisor.