Index Funds for Beginners

I love index funds because they're just so efficient at investing. They are where I get the most bang for my buck. I'm including time spent investing in "buck."

Index funds are the key to beginners being able to invest easily and safely. It would be harder and take far more effort to invest intelligently without them. If you have a 401k, you probably already have some money in index funds. The right combination of index funds is central to good investing.

What is an index fund?

It is a type of mutual fund -- AKA Investment Fund. What is a mutual fund? A mutual fund is basically a group of assets bundled together. You can then buy small pieces of this newly created single asset. For more details click on mutual fund.

An index fund is not managed by a human like most mutual funds. There is no one picking individual stocks. For example, a common index is the S&P 500. This is a list of 500 large and medium sized US companies. The list doesn't change much. When you buy a share of an S&P 500 index fund (there are many companies selling S&P 500 index funds), you own a tiny bit of each of the 500 companies in the list.

Why would you want to invest in an index fund?

• First and foremost, index funds are a key to the Best Way to Invest Money. This method is the have-your-cake-and-eat-it-too of the investment options. You can have safety and gains with very little work. Go ahead and check out the Best Way to Invest Money.
• Its the lowest cost way to get diversification for your investments. Diversified investments are critical to your investing success. You can find companies that will sell you basic index funds with rock bottom expense ratios. In fact, since there's really no difference between one company's S&P 500 index fund and another's, so there's little to no reason to pay more. A difference of 0.2% in expense ratio really adds up over time.
• Looking for an easy way to invest and still get an income? Dividend investing is probably the best option for you. There are many high yield index fund options available to you.
• Occasionally in life a significant amount of money will fall in your lap. I recently got a reader question on lump sum investment. It is not hard to invest this properly and index funds play a huge part in the best strategy.
• Value investing can be a great way to invest in index funds. I especially like small cap value index funds.
• Its the easiest way to invest with diversification. Calling investing in index funds over picking individual stocks "easier" is a massive understatement. In order to pick individual stocks, you have to invest a large amount of time regularly doing research on what you currently own, on potential stocks, on industries, and on general economic conditions. To properly stay up to date, you'll need to spend 15 - 30 hours per week! I'm not looking for a part-time job on top of my full time job. Are you? I'd rather spend that time reading a book and laying out in a hammock...



• Not only is it a lot of work to pick individual stocks, but it doesn't give you more money in the end. You're likely to end up with less money than if you took the "easy" path. In fact, 80-90% of mutual funds lose to index funds after costs are taken into account. That means that you will outperform at least 80% of the professional money managers just by taking the easy path.
• Don't think you can do individual stock picking with little time. As I learned the hard way, you can't pick stocks half-way by putting in half-effort and expecting to do a little better than a broad index. If you try the half-way route, you dramatically increase your chances that you will do worse than the index. I wish I'd listened to Benjamin Graham the first time I read The Intelligent Investor about not going half-way on this.
• They help keep away our worst enemies - ourselves. By making the lows higher and the highs lower, they temper our swings of emotions. You can also be sure that a broad index will never hit 0. However, a single stock may hit zero. For example, a Total US Stock Market index fund will not hit near zero unless civilization has crumbled. If that happens, your investments are the least of your worries.
• My favorite advantage is that I don't have to read balance sheets, earnings reports, and other such business documents. Those put me to sleep. They can be deceiving or flat out lies. I also don't have to know what industry is hot or not. I don't have to know which new products sold like hotcakes or flopped. I just buy the whole market! Then I get back to my life. I can't brag at parties about the stock I bought that tripled over the last month - while conveniently leaving out the details of my big losses, but I feel secure knowing that by investing in the boring way, I've taken the right route.

• Index funds have an interesting off-shoot - exchange-traded funds or ETFs. Basically, for many index funds you can buy a near copy of them on the open stock market. Why would you do this? What are the advantages and disadvantages? Check out the exchange-traded funds and etf investing pages.
• Index investing isn't limited to just stocks. You may also invest in a certain group of bonds or even all bonds. Since bonds are extremely complimentary to stocks, check out bond funds investing.

I've given you many general details about index funds. However, many of you are probably asking, "How do I invest in index funds?" and, "What and where should I invest?" There are different places and ways you can go about index investing. Always keep in mind to look at expense ratios. I recommend checking out the best way to invest money I linked to above.

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