How to Invest in Index Funds: A Beginner's Guide - Deepstash

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What is an Index Fund?

What is an Index Fund?

An index fund is an investment that tracks a market index, typically made up of stocks or bonds.

Index funds typically invest in all the components that are included in the index they track, and they have fund managers whose job it is to make sure that the index fund performs the same as the index does.

You can't invest directly in an index, but you can invest in a fund, through either an index mutual fund or an ETF. 

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What Are the Three Major Stock Indexes?

What Are the Three Major Stock Indexes?

The three most widely followed indexes in the U.S. are the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite.

  • The Standard and Poor's 500 Index is an index of 500 large cap common stocks that represent all different sectors of the market. 
  • The NASDAQ 100 index is the third major stock index. This index is composed of the largest 100 companies that trade on the NASDAQ exchange excluding financials. 
  • The Dow Jones Industrial Average is a stock market index that tracks 30 large, publicly-owned blue-chip companies trading on the New York Stock Exchange (NYSE) and the Nasdaq. 

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CAMBRIDGE DICTIONARY

A blue-chip company or investment is one that can be trusted and is not likely to fail”

CAMBRIDGE DICTIONARY

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Your 3-step process to investing in index funds

Your 3-step process to investing in index funds

  1. Pick the index that you want to track.
  2. Choose a fund that tracks your selected index.
  3. Buy shares of that index fund.

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1. Pick an index

1. Pick an index

There are hundreds of different indexes you can track using index funds. The most popular index is the S&P 500 Index

Here's a short list of some additional top indexes, broken down by what part of the market they cover:

  • Large U.S. stocks: S&P 500, Dow Jones Industrial Average, Nasdaq Composite
  • Small U.S. stocks: Russell 2000, S&P SmallCap 600
  • International stocks: MSCI EAFE, MSCI Emerging Markets
  • Bonds: Bloomberg Barclays Global Aggregate Bond

In addition to these broad indexes, you can find sector indexes, country indexes & so on

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2. Choose the right fund for your index

2. Choose the right fund for your index

Once you've chosen an index, you can generally find at least one index fund that tracks it. For popular indexes like the S&P 500, you might have a dozen or more choices all tracking the same index.

If you have more than one index fund option for your chosen index, you'll want to ask some basic questions:

  1. Which index fund most closely tracks the performance of the index?
  2. Which index fund has the lowest costs?
  3. Are there any limitations or restrictions on an index fund that prevent you from investing in it?
  4. Dowa the fund provider have other index funds that you're also interested in using?

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3. Buy index fund shares

3. Buy index fund shares

To buy shares in your chosen index fund, you can typically open an account directly with the mutual fund company that offers the fund. Alternatively, you can open a brokerage account with a broker that allows you to buy and sell shares of the index fund you're interested in.

Again, in deciding which way is best for you to buy shares of your index fund, it pays to look at costs and features. Some brokers charge extra for their customers to buy index fund shares, making it cheaper to go directly through the index fund company to open a fund account.

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Why invest in index funds?

Why invest in index funds?

  1. Minimize your time spent researching individual stocks. 
  2. You can invest with less risk
  3. Index funds are available for a wide variety of investments. You can buy stock index funds and bond index funds.
  4. It's a lot less expensive
  5. You'll pay less in taxes.
  6. It's a lot easier to stick with your investing plan. When you use index funds, you can automatically invest month after month and ignore short-term ups and down

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Why not to invest in index funds?

Why not to invest in index funds?

  1. You'll never beat the market. 
  2. You don't have any loss protection.
  3. You won't always own stocks you like.

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