Investing in the stock market can seem intimidating. The financial news is filled with complicated charts, talking heads, and stock tips that make investing look like a high-stakes game. Fortunately, the most successful way to invest is actually the simplest and does not require picking individual stocks.
For most beginners, low-cost index funds are the ideal way to build wealth in the market.
What is an Index Fund?
An index fund is a type of mutual fund or exchange-traded fund (ETF) that buys all the stocks in a specific index, such as the S&P 500. The S&P 500 represents the five hundred largest public companies in the United States.
Instead of trying to research and pick the single best company, you buy a slice of all five hundred companies at once. This gives you instant diversification, reducing the risk of one bad company ruining your portfolio.
Broad Index Funds Comparison
Here are some common types of broad index funds that beginners use to build their portfolio:
| Fund Category | Target Index | Index Composition | Ideal For |
|---|---|---|---|
| S&P 500 Index | S&P 500 | 500 largest US large-cap corporations | Steady large-cap exposure (e.g. VOO or SPY) |
| Total Stock Market | CRSP US Total | Over 3,500 US companies of all sizes | Exposure to both large and small US businesses |
| Total International | FTSE Global All-Cap | Over 7,000 non-US companies globally | Geographic diversification outside the US |
Why Index Funds Win
Index funds are passive investments. They do not require expensive fund managers to make decisions, which means their fees are extremely low. These fees, known as expense ratios, are often less than one-tenth of a percent per year.
In contrast, active mutual funds charge high fees to pay managers. Over long periods, more than ninety percent of professional fund managers fail to beat the return of a simple index fund. By keeping your costs low and matching the market return, you beat the majority of professional investors.
How to Get Started
Getting started requires three simple steps:
- Open an account with a low-cost brokerage firm.
- Link your bank account and transfer the money you want to invest.
- Select a broad-market index fund (such as one tracking the S&P 500 or the total stock market) and set up recurring purchases.
Consistency is key. By buying shares regularly, you benefit from dollar-cost averaging, building a solid portfolio over time.