How Easy Getting Money Out of Index Fund

Everyone gushes about index mutual funds, and for good reason: They're an easy, hands-off, diversified, low-cost way to invest in the stock market.

Index fund definition

An "index fund" is a type of investment fund that mirrors the performance of a market index, such as the S&P 500. A market index tracks the performance of a select group of securities. For instance, the S&P 500 market index measures the performance of roughly 500 large-cap companies in the U.S. You can't invest in a specific market index itself, but you can invest in an index fund that tracks it. Your index fund will likely perform very closely to how the index itself performs.

Because index funds passively track an existing index (instead of employing a manager who picks specific stocks to include), they typically have lower fees than actively managed mutual funds. Index funds also tend to generate higher investment returns than actively managed funds.

How index funds work

To understand how an index fund works, it's important to understand the difference between active and passive management. Active management is when an investment manager actively chooses when to buy or sell specific investments. Since there is someone doing the work of choosing these investments, the management fees for actively-managed investments tend to be higher. Many mutual funds use active management strategies.

Passive management, on the other hand, is a strategy where a fund manager builds a portfolio of investments that reflect an existing index, such as the S&P 500. This way, the performance of the index fund usually closely mirrors that of the index, no hands-on management necessary.

Best S&P 500 index funds with low costs

By far, the most popular class of index funds are linked to the S&P 500. Here are some of the best index funds pegged to the S&P 500.

Index fund	Minimum investment	Expense ratio
Vanguard 500 Index Fund - Admiral shares (VFIAX)	$3,000	0.04%
Schwab S&P 500 Index Fund (SWPPX)	No minimum	0.02%
Fidelity 500 Index Fund (FXAIX)	No minimum	0.015%
Fidelity Zero Large Cap Index (FNILX)	No minimum	0.0%
T. Rowe Price Equity Index 500 Fund (PREIX)	$2,500	0.15%

Data current as of Aug. 2, 2022.

Vanguard 500 Index Fund Admiral Shares (VFIAX)

Also known as the Vanguard S&P 500 Index fund, this fund was founded in 1976 and is the granddaddy of all index funds. Like the other S&P 500 funds on this list, this fund gives exposure to 500 of the largest U.S. companies, which make up about 75% of the U.S. stock market's total value.

Schwab S&P 500 Index Fund (SWPPX)

As research firm Morningstar notes, this is one of the cheapest and most accessible S&P 500-tracking funds out there. Launched in 1997, this Schwab fund charges a scant 0.02% expense ratio and requires no minimum investment, making it attractive for investors concerned about costs.

Fidelity 500 Index Fund (FXAIX)

Founded in 1988 (formerly known as Institutional Premium Class fund), Fidelity removed this fund's investment minimum so investors with any budget size can get into the low-cost index fund action.

Fidelity Zero Large Cap Index (FNILX)

In the race for the lowest of the low-cost index funds, this Fidelity fund made news by being among the first to charge no annual expenses, meaning investors can keep all their cash invested for the long run.

T. Rowe Price Equity Index 500 Fund (PREIX)

Founded in 1990, the fund's expense ratio is competitive with other providers, but the $2,500 minimum may be steep for beginning investors.

Index fund costs

Index funds may be less expensive than other funds, but they can still incur some costs.

• Investment minimum. The minimum required to invest in a mutual fund can run as high as a few thousand dollars. Once you've crossed that threshold, most funds allow investors to add money in smaller increments.

• Account minimum. This is different than the investment minimum. Although a brokerage's account minimum may be $0 (common for customers who open a traditional or Roth IRA), that doesn't remove the investment minimum for a particular index fund.

• Expense ratio. This is one of the main costs of an index fund. Expense ratios are subtracted from each fund shareholder's returns as a percentage of their overall investment. Find the expense ratio in the mutual fund's prospectus or when you look up a quote for a mutual fund on a financial site.

• Tax-cost ratio. In addition to paying fees, owning the fund may trigger capital gains taxes if held outside tax-advantaged accounts like a 401(k) or an IRA. Like the expense ratio, these taxes can take a bite out of investment returns.

How to invest in index funds

Investing in index funds is easy. Here's a quick rundown of how to do it:

1. Pick an index

When you're investigating an index, it's important to consider several different factors. Here are some things to keep in mind:

• Company size and capitalization . Index funds can track small, medium-sized or large companies  (also known as small-, mid- or large-cap indexes).

• Geography. There are funds that focus on stocks that trade on foreign exchanges or a combination of international exchanges.

• Business sector or industry. You can explore funds that focus on consumer goods, technology, health-related businesses.

• Asset type.  There are funds that track domestic and foreign bonds, commodities, cash.

• Market opportunities.  These funds examine emerging markets or other nascent but growing sectors for investment.

Despite the array of choices, you may need to invest in only one. Investing legend Warren Buffett has said that the average investor need only invest in a broad stock market index to be properly diversified. However, you can easily customize your allocation if you want additional exposure to specific markets in your portfolio (such as more emerging market exposure, or a higher allocation to small companies or bonds).

Index examples

Index mutual funds track various indexes. The Standard & Poor's 500 index , also known as the S&P 500, is one of the best-known indexes because the 500 companies it tracks include large, well-known U.S.-based businesses representing a wide range of industries.

But the S&P 500 isn't the only index in town. Here are some other options:

• Nasdaq Composite: Follows more than 3,000 equities listed on the Nasdaq stock exchange and is largely tech-focused.

• Dow Jones Industrial Average: Measures 30 blue-chip companies in the U.S. and covers all industries except for transportation and utilities.

• Wilshire 5000: Includes all of the publicly traded companies with headquarters in the United States and available price data; often called the "total stock market index."

• FTSE Global All Cap: Features a broad range of stocks across several market caps within the U.S. and across the globe; covers developed and emerging markets.

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2. Select an index fund

Once you've decided which index you're interested in, it's time to choose which corresponding index fund to buy. Oftentimes, this boils down to cost.

Low costs are one of the biggest selling points of index funds. They're cheap to run because they're automated to follow the shifts in value in an index. However, don't assume that all index mutual funds are cheap.

Even though they're not actively managed by a team of well-paid analysts, they carry administrative costs. These costs are subtracted from each fund shareholder's returns as a percentage of their overall investment.

Two funds may have the same investment goal  — like tracking the S&P 500 — yet have management costs that can vary wildly. Those fractions of a percentage point may seem like no big deal, but your long-term investment returns can take a massive hit from the smallest fee inflation. Typically, the bigger the fund, the lower the fees.

3. Decide where to buy your index fund

You can purchase an index fund directly from a mutual fund company or a brokerage. Same goes for exchange-traded funds (ETFs), which are like mini mutual funds that trade like stocks throughout the day (more on these below).

When you're choosing where to buy an index fund, consider:

• Fund selection. Do you want to purchase index funds from various fund families? The big mutual fund companies carry some of their competitors' funds, but the selection may be more limited than what's available in a discount broker's lineup.

• Convenience. Find a single provider who can accommodate all your needs. For example, if you're just going to invest in mutual funds (or even a mix of funds and stocks), a mutual fund company may be able to serve as your investment hub. But if you require sophisticated stock research and screening tools, a discount broker that also sells the index funds you want may be better. (If you don't have a brokerage account, here's how to open one .)

• Trading costs . If the commission or transaction fee isn't waived, consider how much a broker or fund company charges to buy or sell the index fund. Mutual fund commissions are higher than stock trading ones, about $20 or more, compared with less than $10 a trade for stocks and ETFs.

• Impact investing. Want your investment to make a difference outside your portfolio? Some index funds track benchmarks that target companies with a focus on environmental or social justice causes. Learn more about impact investing .

• Commission-free options. Do they offer no-transaction-fee mutual funds or commission-free ETFs? This is an important criterion we use to rate discount brokers.

4. Purchase shares of the index fund

In order to purchase shares of an index fund, you'll need to do so from an investment account. You can then open an investment account, such as a traditional brokerage account or a Roth IRA, through the brokerage you picked in step 3. You can then buy the fund from that account.

When you go to purchase the fund, you may be able to select a fixed dollar amount to spend or choose a number of shares. The share price of the index fund, and your investing budget, will likely determine how much you're willing to spend. For instance, if you have $1,000 you'd like to invest in an index fund, and the fund you're looking at is selling for $100 a share, you'd be able to purchase 10 shares.

Other index fund considerations

Index funds have become one of the most popular ways for Americans to invest because of their ease of use, instant diversity and returns that typically beat actively managed accounts. Some additional things to consider:

• Is the index fund doing its job?  Your index fund should mirror the performance of the underlying index. To check, look at the index fund's returns on the mutual fund quote page. It shows the index fund's returns during several time periods, compared with the performance of the benchmark index. Don't panic if the returns aren't identical. Remember, those investment costs, even if minimal, affect results, as do taxes. However, red flags should wave if the fund's performance lags the index by much more than the expense ratio.

• Is the index fund you want too expensive? Invest in an exchange-traded fund that tracks the index. Instead of having to buy the main-course mutual fund, you purchase just a slice of the fund. (Here are some pros and cons of investing in ETFs versus mutual funds .)

• Want to buy stocks instead? If you want to be hands-on with your investments, you may want to explore stocks. Learn how to trade stocks with these step-by-step instructions.

Can you lose money in an index fund?

As with all investments, it is possible to lose money in an index fund, but if you invest in an index fund and hold it over the long-term, it is much more likely that your investment will increase in value over time. You may then be able to sell that investment for a profit.

Is now a good time to buy index funds?

If you're planning to invest for the long-term, dips or highs in the market become less relevant. If you're worried about buying an index fund at a high, keep in mind that if you're invested in that fund for many years, that high will look much smaller down the road. Check out our investment calculator to explore how an investment in an index fund or other security could grow over time.

Neither the author nor editor held positions in the aforementioned investments at the time of publication.

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Source: https://www.nerdwallet.com/article/investing/how-to-invest-in-index-funds

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