Plenty of people shy away from investing because of fear.
In fact, a survey from Ally Invest found that 65% of adults say they find investing in the stock market to be scary and/or intimidating. Whether it's the concern you'll make a bad investment and lose money or a lack of access to quality investing advice, at the end of the day that fear is holding you back from really growing your net worth.
The good news is there are many easy ways to invest; you don't have to worry about picking individual stocks, and hiring an expensive advisor isn't always necessary. One of the easiest ways to get started investing is through index funds.
How index funds work
Index funds are investment funds that follow a benchmark index, such as the S&P 500 or the Nasdaq 100.
When you put money in an index fund, that cash is then used to invest in all the companies that make up the particular index, which gives you a more diverse portfolio than if you were buying individual stocks.
Let's use the S&P 500 as an example. The S&P 500 is one of the major indexes that tracks the performance of the 500 largest companies in the U.S. Investing in an S&P 500 fund (one of the most popular) means your investments are tied to the performance of a wide range of companies.
Because the goal of index funds is to mirror the same holdings of whatever index they track, they are naturally diversified and thus hold a lower risk than individual stock holdings. Market indexes tend to have a good track record, too. Though the S&P 500 certainly fluctuates, it has historically generated nearly a 10% average annual return over time for investors. (Just remember that future returns are not guaranteed.)
Index investing is a form of passive investing
Index investors don't need to actively manage the stocks and bonds investment as closely since the fund is just copying a particular index. This is why index funds are known as passive investing — and it's what sets them apart from mutual funds.
Mutual funds are actively managed by fund managers who choose your investments. The goal with mutual funds is to beat the market, while the goal with index funds is simply to match the market's performance. Since index funds don't require daily human management, they have lower management costs (called "expense ratios") than mutual funds. The money saved in fees by investing in an index fund over a mutual fund can save you lots of money in the long term and in turn help you make more money.
A common strategy for many investors who have a long investment timeline is to regularly invest money into an S&P 500 index fund (known as dollar-cost averaging) and watch their money grow over time.
Get started index investing with a brokerage account
Some of the top index funds are those that track the S&P 500 and have low costs. For example, Charles Schwab's S&P 500 Index Fund (SWPPX) is a straightforward option with no investment minimum. Its expense ratio is 0.02%, meaning every $10,000 invested costs $2 annually. Passive, or index funds, generally have a 0.2% expense ratio, so this is notably low.
For an option with no expense ratio, consider the Fidelity ZERO Large Cap Index (FNILX). Though the fund doesn't technically track the S&P 500, the Fidelity U.S. Large Cap Index tracks large capitalization stocks, which the website says, "are considered to be stocks of the largest 500 U.S. companies."
To invest in an index fund, you'll need to open a brokerage account, a traditional IRA or a Roth IRA (you can often choose to invest in index funds through your employer's 401(k) too). Once your account is open and funded, you can choose from a number of different index funds, like an S&P 500 fund, a fund that tracks government bonds or a fund that tracks international stocks.
Also, consider using a robo-advisor like Wealthfront and Betterment (which Select rated highly on our list of the best robo-advisors), which will invest in a handful of index funds and ETFs based on your risk tolerance and investment timeline. Robo-advisors will automatically rebalance your portfolio based on market conditions and have much lower fees than traditional financial advisors.
Read more
A robo-advisor can invest on your behalf — here’s how they work
Here’s how much money you should be investing in your 401(k)
Socially responsible investing can help you make a positive impact: Here’s what you need to know
Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
FAQs
An index fund is a type of investment that tracks a specific stock market index, like the S&P 500 or the Dow Jones. By allowing you to invest in hundreds or thousands of stocks within a single fund, index funds offer an easy way to diversify your portfolio—and most are affordable, too.
Is it easy to invest in index funds? ›
Ease of use: For investors who don't have the time to research individual stocks, or aren't interested, index funds offer an easy way to access broad market exposure.
What is index fund and how does it work? ›
An index fund is a type of mutual fund or exchange-traded fund that aims to mimic the performance of an index, such as the S&P 500®. Index funds tend to offer investors lower costs and taxes than some other types of funds. They're also relatively lower maintenance.
What are the pros and cons of index funds? ›
Index funds are a low-cost way to invest, provide better returns than most fund managers, and help investors to achieve their goals more consistently. On the other hand, many indexes put too much weight on large-cap stocks and lack the flexibility of managed funds.
Do index funds make you rich? ›
Index funds are a great investment for building wealth over the long-term. That's one reason they're popular with retirement investors.
How do you actually make money from index funds? ›
As with other mutual funds, when you buy shares in an index fund you're pooling your money with other investors. The pool of money is used to purchase a portfolio of assets that duplicates the performance of the target index. Dividends, interest and capital gains are paid out to investors regularly.
Why I don't invest in index funds? ›
Index investing does not allow for advantageous behavior. If a stock becomes overvalued, it actually starts to carry more weight in the index. Unfortunately, this is just when astute investors would want to be lowering their portfolios' exposure to that stock.
Is it easy to take money out of an index fund? ›
Capital gains taxes on that sale are yours and yours alone to pay. To get cash out of an index fund, you technically must redeem it from the fund manager, who will then have to sell securities to generate the cash to pay to you.
Is it smart to put all your money in an index fund? ›
Short-term downside risk: Index funds track their markets in good times and bad. They can be volatile places to put your money, especially when the economy or stock market isn't doing particularly well. When the index your fund is tracking plunges, your index fund will plunge as well.
How long do you keep your money in an index fund? ›
Ideally, you should stay invested in equity index funds for the long run, i.e., at least 7 years. That is because investing in any equity instrument for the short-term is fraught with risks. And as we saw, the chances of getting positive returns improve when you give time to your investments.
They can offer reasonable returns
But not every index fund does well. However, history shows that the stock market increases in value over time. It means, in the long run, index funds have the potential to provide investors with reasonable returns for a low cost, making them good value for money.
What are the risks of index funds? ›
While they offer advantages like lower risk through diversification and long-term solid returns, index funds are also subject to market swings and lack the flexibility of active management.
Is index fund better than stock? ›
The diversification inherent in an index mutual fund helps spread the risk across different companies and sub-sectors, reducing the impact of any single stock's poor performance. Moreover, index funds are passively managed, which typically results in lower expense ratios compared to actively managed funds.
Can I live off index funds? ›
The short answer is a resounding yes. Let's take a look at why this is. While past investment performance doesn't guarantee future results, the return of S&P 500 index funds has been about 9% to 10% annualized per year over long periods, depending on the exact timeframe you're looking at.
Can you become a millionaire from index funds? ›
To build wealth in index funds, you need discipline, money, and time. It is easy to become a millionaire using index funds with all three ingredients but becoming one in 10 years means you have less time.
What is the highest paying index fund? ›
Compare the best S&P 500 index funds
| FUND | TICKER | 10-YEAR RETURN AS OF JUNE 30 |
|---|
| Fidelity 500 Index Fund | FXAIX | 12.85% |
| Vanguard 500 Index Fund Admiral Shares | VFIAX | 12.82% |
| Schwab S&P 500 Index Fund | SWPPX | 12.80% |
| State Street S&P 500 Index Fund Class N | SVSPX | 12.72% |
FNILX and QQQM are often described as some of the best index funds for beginner investors.
How much money do you need to buy an index fund? ›
How much is needed to invest in an index fund? The minimum needed depends on the fund and your broker's policies. If your broker allows you to buy fractional shares of stock, you may be able to invest in index fund ETFs with as little as $1. If not, your minimum investment will be the cost of one share of the ETF.
Is it hard to beat index funds? ›
A small minority of active managers will outperform an index product over the next 10 years. However, there is no way to identify these firms in advance. Some financial advisers may be tempted to dispute the evidence that low-fee products will likely provide a higher net return.
