How To Buy Index Funds (2024)

Index funds, which buy a basket of assets to track the performance of indexes like the S&P 500, are investment portfolio staples due to their low-cost, diverse nature. Here’s how you can easily and cheaply buy index funds to reach your investing goals.

1. Open an Investment Account

You’ll need an investment account to buy index funds. Different kinds of investment accounts are best suited for different types of goals:

• Financial Goals. Taxable brokerage accounts are a great way to build wealth, but as the name suggests you may owe taxes on any income, like dividends or profitable asset sales. Taxable accounts are best for financial goals other than retirement, like a home down payment. They’re also a good choice when you’ve already maxed out your retirement contributions for the year.
• Retirement. Retirement accounts like an IRA or a 401(k) provide tax benefits to help you save for retirement. These accounts are best for long-term investing. Withdrawals before retirement could incur penalties and taxes.
• Educational Expenses. Check out 529 plans for investing to pay for educational expenses. You may be able to deduct contributions from your taxes, the investments grow tax free while they’re in the account, and you might not have to pay taxes on withdrawals used for eligible education expenses.
• Children. Custodial accounts, also known as UTMA/UGMA accounts, let you invest on behalf of a child. Cash and investment assets in the account become the child’s property when they reach a designated age, usually 18 to 25, depending on the state the account is held in.

If you’re a self-directed investor who likes researching and learning about stocks and bonds, choose an online brokerage account.

If you’re more of a hands-off investor, consider hiring a financial advisor to manage your index fund portfolio and other investments. You’ll generally pay a percentage of your total assets under management each year.

A less-expensive managed investment is a robo advisor. Answer some questions about your risk tolerance, timeline and goals, and an algorithm recommends a portfolio mix for you. Robos like Betterment and Wealthfront, for instance, charge 0.25% of assets each year.

2. Decide on Your Index Fund investment Strategy

Your index fund investment strategy takes into account your overall financial goals, risk tolerance and timeline.

If you’re working with a financial advisor, they’ll help you determine the best mix of funds for your situation. If you open an account with a robo-advisor, the algorithm will suggest a strategy based on your answers to questions when you open the account.

If you’re choosing an index fund allocation on your own, it may help to use an online tool to steer you in the right direction. Vanguard, for instance, offers an online questionnaire on your timeline, risk tolerance and investing preference to recommend an index fund asset mix for you. Fidelity offers investment tools you can use without creating an account, such as the ability to create an investment strategy.

In general, advisors recommend keeping more of your portfolio in stocks and less in fixed-income products like bonds when you’re further from a goal. As you get closer to the goal, gradually adjust the mix away from stock and into bonds.

How aggressive you are—reflected in the ratio of stock index funds to bond index funds—depends on how much risk you’re willing to take on. For shorter term goals less than three years away, you may be better off with high-yield savings accounts or certificates of deposit (CDs). For longer-term goals that are more than three to five years out, consider taking on more risk by investing in stock index funds.

3. Research Your Index Funds

It’s important to know what you’re getting in an index fund, so research is key.

First, pick an index—or more than one index. The is probably the most well-known index, but there are also indexes based on company size, business sector and market opportunity, such as emerging markets.

Equity indexes are generally well suited to adding growth potential (and risk) to your portfolio, and the more niche your equity index, generally the more risk you’re taking on. Bond-based indexes add stability to investment portfolios and more modest returns.

Indexes to start your search with include:

• Broad market indexes like the Dow Jones Industrial Average (DJIA), S&P 500 Index, NASDAQ and Wilshire 5000 Index. Funds tracking one of these core indexes are commonly chosen by those looking to construct simple two- or three-fund portfolios.
• Equity indexes that group companies by size like the Russell 3000 Index (large-cap companies), Russell 2000 Index (small-cap companies) and S&P 400 Index (mid-cap companies). Generally, the smaller the companies in an index, the more risk and growth potential you take on.
• Indexes offering exposure to stocks from companies outside of the U.S., like the MSCI Indexes. Usually, the less developed a country’s economy, the more risk and growth potential you take on.
• Indexes based in the bond and fixed income markets, such as the Barclays Capital Aggregate Bond Index. Indexes with corporate bonds typically offer higher returns (and more risk) than those that only invest in government bonds.

Once you’ve settled on an index or indexes, you’re ready to research individual funds. When you’re comparing index funds, here are some things to consider:

• Expense Ratio. This is the cost to administer the fund each year. All things being equal, index funds based on the same index all track the same thing, so expense ratio can be a big deciding factor. If one fund charged 0.19% and another charged 0.03%, you’d save $16 a year per $10,000 you invested by going with the lower cost fund.
• Other Fees. You can generally avoid trading fees on index funds at most major brokerages, but be sure to look out for loads, or special fees charged by certain mutual funds when you buy or sell them. You should be able to find index funds for any index without load fees at most major brokerages, so don’t opt for a fund with loads just because it’s the first you’ve found.
• Investment Minimums. If you don’t have the cash to meet the minimum investment required, you can cross that fund off your list. If you really want to buy into that particular index, you should look for the exchange-traded fund (ETF) version of that fund, which will typically have no minimum beyond the price of one share.

Keep in mind that index funds tracking the same index at different companies will have virtually identical holdings, so expenses should be your primary focus.

“In reality, if you choose an index like the S&P 500, and you start to say, ‘Do I want Vanguard, Fidelity or Schwab,’ they’re essentially the same,” says Ron Guay, a certified financial planner (CFP) in Sunnyvale, Calif. “You’re buying the same content, and you’re just choosing a different wrapper or brand.”

That means you’ll want to pay attention to expense ratios, trading fees and loads. You’ll probably want to choose the index funds offered in-house by your brokerage of choice to minimize fees.

4. Buy the Index Funds

Once you have a brokerage account, you can buy shares of the index funds you’ve settled on. Generally, you’ll search for or type in the ticker symbol of the fund you want to purchase and the dollar amount you want to invest.

You’ll need to buy enough to reach the fund’s investment minimum, but after you do, you can typically buy fractional shares going forward. The site may ask for your preference regarding dividends—whether they should be used to purchase additional fund shares or deposited into your account as cash.

If you’re reinvesting for the long term, most experts recommend you reinvest your dividends because historically dividends have been responsible for substantial investment growth.

5. Set Up Your Purchase Plan

Investing is typically an ongoing practice, so you’ll need to think about your plan for buying index funds over time. Financial advisors often recommend dollar-cost averaging—the practice of putting a certain amount of money into your investments at set intervals.

“The beauty of dollar cost averaging is that investors add to their portfolio in high and low markets, eliminating the emotional push to buy high and sell low,” says Erika Safran, a CFP in New York City.

To make this happen, set up automatic investments that happen on a schedule (such as once a month or every payday) with your brokerage. This ensures that you’ll continue to invest on a regular schedule.

In general, investing is about the long game: Although the stock market has its short-term ups and downs, over your investing life, buying and holding a diverse investment mix historically results in successful returns.

For best results, review your portfolio every six to 12 months and rebalance when your investments have drifted too far from your original allocation. To rebalance, you’ll sell some of the categories that have gotten too large and buy more of the category that’s gotten too small. This helps keep your portfolio on track to reach your goals.

6. Decide on Your Exit Strategy

Although buying and holding is a solid investment strategy, you should also think about when and how you’ll sell your shares.

If you’re investing in a taxable account, you’ll have to consider capital gains taxes and whether you can offset gains with losses in other investments through a process called tax-loss harvesting. If you’re in a tax-advantaged retirement account, you’ll want to brainstorm ways to minimize the taxable income you earn each year through retirement account withdrawals.

A financial advisor or tax professional can help you figure out the best strategies for managing withdrawals from any type of investment account.

What Is an Index Fund?

An index fund is a type of mutual fund that aims to track a market index, such as the S&P 500 or the Russell 2000.

Because they aim to duplicate the makeup of a market index, there are lower costs to own an index fund. While many other types of mutual funds pursue an active investing strategy, with fund managers picking winning investments, index funds are considered to be a form of passive investing.

The overall long-term performance of index funds has historically exceeded that of actively managed funds.

How Do Index Funds Work?

An index fund pools money from many investors to buy a diversified portfolio of stocks, bonds or other assets.

Fund managers maintain the asset allocation by tracking an index. Index funds typically have low minimum investment requirements, and investors get access to excellent liquidity as fund will always redeem their shares at short notice.

Each share of the index fund represents an investor’s proportionate ownership of the fund’s portfolio and the income the portfolio generates. Index fund shares are typically purchased in different investing accounts, like an individual retirement account (IRA) or a brokerage account.

What’s the Difference Between an Index Fund and an ETF?

The biggest difference between an index fund and an ETF is the way they’re traded. An ETF is traded like a stock—you can buy and sell it throughout the day. An index fund can only be bought and sold at the price set when the trading day ends.

Like index funds, ETFs pool money from many investors and put the money into a diversified portfolio of stocks, bonds or other assets. When investors buy shares, they receive an interest in that investment pool.

Unlike index funds, ETFs do not sell shares directly to investors or redeem them on demand. Instead, ETF shares are traded throughout the day on stock exchanges at market prices.