Index Fund Strategy
Updated on March 13, 2019
Want to invest at a low cost? Trying to buy all your favorite stocks? Looking to grow your money with minimal effort? Well, the Index Fund Strategy is for you!
The Index Fund Strategy allows you to take a “hands-off” but lucrative approach to investing. You won’t even have to know how to analyze a stock chart or read a company’s balance sheet. This strategy involves regularly buying index funds such as Exchange-Traded Funds (ETFs) or Mutual Funds that track major indices like the Dow Jones, S&P 500, and the NASDAQ. Although these indices consist of tens to hundreds of stocks, index funds allow you to buy them all at once and at a low cost. This is because ETFs and Mutual Funds are “baskets” of stocks, bonds, and other investments that you can buy as a single share.
As an example, the S&P 500 includes 500 of some of the largest and most successful U.S. companies. If you wanted to buy 1 share of every company in the S&P 500, it would require a lot of cash. Instead, you can buy one index fund that tracks the S&P 500 for a few hundred dollars. Without index funds, it would take thousands of dollars to build a truly diverse portfolio. Fortunately for investors, index funds enable you to accomplish this with a lot less.
Index funds also make it possible for you to easily invest in the first two asset classes of the asset allocation strategy: stocks and bonds. Because there is a wide variety of ETFs and mutual funds that track either group, it is easy to buy only a few index funds and accomplish a diversified and properly allocated portfolio.
ETFs vs. Mutual Funds
So you may be wondering, “should I use ETFs or mutual funds with this strategy?” While both have a lot in common, there are some key differences that will help you make this decision.
- ETFs only require you to have enough money to purchase one share while mutual fund minimums can start in the thousands.
- ETFs can also be traded like stocks throughout the day, while mutual funds can only be bought or sold at the end of each trading day.
- ETFs typically have expense ratios less than or equal to mutual funds. Expense ratios are fees charged by a fund manager for managing your ETF or mutual fund. Although mutual fund expense ratios can tend to be slightly higher than ETFs, both usually charge less than 1%.
- ETFs also tend to save you more money on taxes. This is because you only pay capital gain taxes on ETFs when you sell them, while mutual funds tend to require you pay taxes every year.
- Mutual funds do have some advantages though. Index mutual funds don't require investors to pay a commission to an online broker, but ETFs do. Although, many online brokers have started to offer a large selection of commission-free ETFs.
- Index mutual funds also allow automatic deposits into your investment, even if your deposit amount is not enough to buy a full share. ETFs, on the other hand, require investors to buy whole shares, making the process a bit more difficult and often leaving at least some cash unused in your account.
Ultimately you’ll have to decide on which index fund is the best for you, but either will serve as a great investment choice!
Taking This Strategy To The Next Level
So now that you know what the index fund strategy is and you’ve decided on whether you’ll use ETFs, mutual funds, or a combination of both, it’s time to take this strategy to the next level.
In order to maximize your gains using the index fund strategy, you should strongly consider using commission-free index funds, adding cash to your investments on a regular basis, choosing the funds with the lowest net expense ratios, and holding these investments through the ups and downs over a long period of time. History shows this will allow your money to grow at the largest rate possible.