Saving Money with Low-Cost Index Funds
Successful investing requires many factors and often hinges on avoiding big mistakes. You need to acquire a diverse set of promising assets (at good prices), hold them in a tax-efficient manner for a long time (often extending beyond 25 years), and let time and the market do the rest. Index funds are a tried-and-true way for investors to take advantage of this approach.
What Will I Miss by Paying Lower Fees?
Sometimes, higher fees may be worth the benefits you receive from managed funds. For example, in many cases, an investment advisor or wealth management company may provide added value in the form of advice, tax strategy, or risk monitoring, and may even help with specialized issues like estate taxes and intergenerational tax transfers (for instance, using family limited partnerships and liquidity discounts to overcome gift tax limits). In such cases, you should be cautious of cost ratios exceeding 1%, or paying more than 1% annually in fees.
What Initial Costs Can I Expect?
If you are a small investor looking to replicate the S&P 500 index, you could take the DIY approach and buy shares of each of the 500 stocks directly. There’s a reason people don’t do that. To accurately replicate a large index by yourself, you’ll need to spend thousands of dollars in commissions to cover all the numerous transaction fees and invest millions of dollars. Many discount brokers have started to offer index funds with small or even no minimum investment requirements. In 2018, Fidelity Investments made headlines when it began offering four index funds with no minimum investment and no transaction fees.
Low-Cost Index Funds Available for All Asset Classes
Low-cost index funds have become so popular that there are now funds covering all types of orders and asset allocations. You can invest in an index tracking the asset class or sector of your choice, such as small-cap stocks, consumer goods, energy stocks, and international pharmaceuticals. The cost ratios for these funds are often quite reasonable and below 0.2%.
Are Index Funds Always Safe?
Not all index funds are regulated in the same way. Some may not be suitable for new investors, such as those holding assets in foreign currencies. For all intents and purposes, an index fund is no more or less safe than the underlying investments it contains. If you were to put 100% of your net worth into an index fund that favors junk bonds, for example, you would not really be diversified, as you would only own many securities within the same asset class.
Advantages of Passive Investing
Once you find an index fund that meets your needs and risk tolerance level, the idea is to buy it so that you won’t have to spend your free time worrying about any individual asset. You won’t have to decide whether Procter & Gamble is worth more than Colgate-Palmolive or whether U.S. Bancorp is cheaper than Wells Fargo. You won’t have to watch oil stocks plummet 50% due to an overload in commodity markets or see your airline stocks go bankrupt after a major event that changes the pattern, like the September 11 attacks.
Instead, you will gain freedom from worrying about every individual investment. Peace of mind can be a significant asset for the new investor.
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Sources:
Investment Company Institute. “ICI Research Perspective: Trends in the Expenses and Fees of Funds, 2018.” Pages 1, 16.
Fidelity. “Mutual Fund Investing Ideas.”
U.S. News & World Report. “Guide to Low-Cost Index Funds.”
Source: https://www.thebalancemoney.com/index-funds-new-investors-357945
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