How to make money from an index
What is the index?
The Dow, the S&P 500, the Nasdaq 100, the Wilshire 5000 are all examples of indexes. Each of them are a group of stocks chosen to represent portions of the stock market. Most of them are based on the stocks of a certain number leading companies in leading industries (so the S&P 500 has 500 stocks in 500 leading companies in large industries).
Why should you invest in an Index?
Indexes have consistently outperformed actively managed mutual funds over the last 10 years (once you take into account the cost of the commission). One of the reasons index investing has done so well is because it’s so cost-efficient. Index funds just invest in whatever companies are in the index this means no MBA-toting analysts will ever be needed, so no more massive fees will ever be needed either.
How to buy into an index fund
There are two main ways to invest in indexes: through mutual funds and through “exchange-traded funds” (ETFs), which trade like regular stocks on the American Stock Exchange. In terms of return there is no way to choose between them, however there are a few things to consider when choosing which one to invest in.
- Index funds: Can have high minimum investments, but those are often waved if you enrol in an automatic investment program (which regularly transfers money from your checking account to your fund each month). You can invest in a mutual fund directly through the mutual fund family or through your brokerage account.
- Exchange-Traded Funds (ETFs): Because they are bought and sold just like stocks, you must have a brokerage account. (If you don’t, or you want to see how yours stacks up, visit our Broker Center). This means you’ll pay a commission each time you buy or sell.
Choose the right fund
Index funds and ETFs charge investors annually for the costs of running the fund. This is known as the expense ratio, and it’s calculated as a percentage of the amount you have invested. There’s no need to invest in an index fund or ETF with an expense ratio greater than 0.4%.