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The scariest part of investing isn’t wondering if you have enough money or watching your savings diminish.
It’s getting started.
When you don’t have a ton of money, it’s nerve-wracking to put it in a metaphorical shoebox that you can’t access for decades, even when everyone’s telling you now is the best time to start.
When my husband and I started thinking about retirement last year, we were in the same place.
We went searching for information and found that everyone who knows anything about investing has a strong opinion about it, regardless of how much they actually know.
The easiest and most common options in 401(k) plans and IRAs are mutual funds, but there are still a plethora of funds to choose from.
After talking to a number of investment professionals and personal finance writers, we found one type of investment that nobody had anything bad to say about: index funds.
What’s So Great About Low-Cost Index Funds?
An index fund is a type of mutual fund or exchange-traded fund (ETF) designed to track the performance of an index by including the same individual stocks as the index.
You may have heard of the S&P 500 or Dow Jones Industrial Average. Those are examples of indexes that index funds try to match.
For example, the S&P 500 includes 500 of the largest publicly traded companies America, so an S&P 500 index fund will have all 500 — give or take a few — of those companies’ stocks in it.
People love index funds for two main reasons.
- The fees are really low. The goal is to pay as little in investment fees as possible. Index funds have some of the lowest fees of any investment vehicle.
Robert Farrington from TheCollegeInvestor.com helps millennials navigate investing for the first time and loves index funds for that reason.
“One of the biggest things that erodes your investment gains is fees. The less fees, the more money you can keep in your pocket,” he said. “What many people don’t realize is that non-index funds can charge fees upward of 1% per year or more. Index funds can have fees as low as 0.03% per year — that’s a huge savings and simply equates to more money in your portfolio.”
And you’ve heard of Warren Buffett, right? That famous businessman who invests for a living and has a net worth of over $84 billion?
While Buffett actively invests in single stocks, for the average citizen who doesn’t enjoy reading about that stuff all day, he recommends low-cost index funds.
Because index funds aren’t actively managed, the fees associated with them are super low. With low fees, more of your money can compound interest compared to actively managed funds with higher fees.
Buffett actually bet $1 million that he was right — by pitting an index fund against a basket of hedge funds for 10 years — and won by a landslide.
- They’re well-diversified. Erik Tozier, from The Mastermind Within, prefers index funds because they provide instant diversification for any portfolio size.
“It’s unfortunate, but it’s a fact that some companies will fail. It’s also a fact that some companies will outperform others,” he said. “Humans don’t have crystal balls, and to be able to select which ones will fail and which ones will perform well is nearly impossible.”
By having low-cost index funds, you own a little piece of a lot of companies, as opposed to an actively managed fund that typically includes fewer companies. So if one company fails, it’s backed up by many more successful companies. And on average, you’ll trend with whatever index your fund is tracking.
While some naysayers think index funds will kill the market, Camilo Maldonado of The Finance Twins said that index funds are still a small percentage of the overall stock market, and they’re likely to stay that way.
“Only about 40% of the stock market is owned by indexers, which is well below the 75-85% threshold that leading economists and investors, like Warren Buffett, warn against,” he said. “What this means is that investing in index funds will continue to be a viable investment for many years to come, since there’s no certain indication that those levels will ever be reached. After all, there’s always someone willing to bet that they can beat the market average.”
How to Invest in Index Funds
You can add index funds to almost any retirement or investment account. And because the funds are so broad, you don’t need many to diversify.
The easiest place to start is in your traditional or Roth IRA.
If you don’t already have one you can open an IRA brokerage account with a company like Vanguard, Charles Schwab, Fidelity or BlackRock. Each company has its own selection of index funds and minimum balances to open, so check each to find the company that’s right for you. You’ll want to look for fees that are less than 1%.
Your 401(k) may have more limited options.
Wherever you choose to put them, including low-cost index funds in your portfolio is likely to result in fewer fees flying out of your accounts and more money for you in retirement.
This article contains general information and explains options you may have, but it is not intended to be investment advice or a personal recommendation. We can’t personalize articles for our readers, so your situation may vary from the one discussed here. Please seek a licensed professional for tax advice, legal advice, financial planning advice or investment advice.
Jen Smith is a staff writer at The Penny Hoarder and maxes out her 401(k) and Roth IRA contributions, all in index funds. She gives money saving and debt payoff tips on Instagram at @savingwithspunk.
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