Index funds are one of my favorite ways to invest my money. It’s so easy to start with. That’s why it’s perfect for beginners like you, who want to start investing. In today’s blog I will tell you everything you need to know about investing in index funds for beginners. What are index funds? What are the benefits of index funds? How can you invest in index funds? What are the best index funds to invest in? Let’s get started!
What are index funds?
The “index” part of index funds refers to a list of stocks or bonds put together based on certain rules. An index is a standard measure of the fluctuations in the performance of a group of stocks; a group which acts as a benchmark for the stock market as a whole or for specific parts of a market. The rules of how to construct a portfolio of individual holdings are drummed up by a person or a group of people.
So what is an index fund? This is a type of mutual fund with a portfolio that tries to track the components of a market index, like the famous S&P 500 and the Dow Jones. So for example, if you buy an index fund that tries to track the Dow Jones, you will buy shares of all the stocks that are in the Dow Jones stock index. So the Dow Jones index fund will follow the performance of the real Dow Jones stock index. You can also choose to track a certain sector or area, like sustainability index funds or Pacific index funds. So it’s not limited to a stock market index.
What is the difference between index funds and mutual funds?
Like I just told you, index funds are a type of mutual funds. So what is the difference between index funds and regular mutual funds? Well, regular mutual funds are actively managed funds, while index funds are not actively managed. Regular mutual funds have a fund manager, who selects stocks and bonds and tries to time the market by buying and selling stocks and bonds at the right moment, so he can eventually beat the market.
Index funds are not actively managed by a fund manager, but computers track the market and ensure that the index fund is tracking the stock market index. So a index fund doesn’t try to beat the market, but is just tracking the market as it is.
So which one is better, mutual funds or index funds? Well in my opinion index funds are better, because they are cost-efficient and they are not trying to beat the market. You can imagine that a fund manager of a regular mutual fund means higher costs. Therefore, regular mutual funds are more expensive than index funds, due to the managing fees. And what about beating the market? Well, research has found out that you can’t beat the market. Over the years index funds are performing better than the actively managed mutual funds. So you are paying more for a mutual fund, while they are performing less than the index fund. Index funds or mutual funds? I think this is an easy decision.
What are the benefits of index funds?
1. Simplicity: Index funds just track the market. There’s nothing complicated about it. It is much easier to buy and hold than traditional mutual funds. As I said, you can try to beat the market, but results have shown that index funds are still performing better. This doesn’t mean that you can’t lose money. If you have a index fund that follows a stock index market that is not performing well, your index fund is not performing well either.
2. Low costs: With this simplicity come low costs and a much lower expense ratio. You have no fund manager who tries to beat the market, it all goes passively. So you save on managing fees and transaction fees.
3. You don’t have to bother about calculations: So many people stay away from investing because of the numbers involved. Interest rates, compound ratio and all do more harm than good. If you’re one of them, index funds give you a picture of the total portfolio rather than breaking down the underlying components.
4. Diversified portfolio: With a list of stocks, it doesn’t get any more diversified than with index funds. Off course, this also depends on the index funds you choose. You have index funds who only has 100 stocks of one country, but you also have index funds who has 3000 stocks all over the world. You can imagine that the second option is more diversified.
5. Consistency: Active investing is a lot of work. There’s more than enough to track and it can be pretty difficult to be consistent. On the other hand, investing in index funds is all about passive investing. You see, it makes it easy for you to stay consistent. All you will be doing is choosing the right index funds that will keep on tracking the markets.
How to start investing in index funds?
This guide on investing in index funds for beginners is incomplete without teaching you the steps to take to get started.
Decide where to buy your index funds. Two places it can be purchased from are from a mutual fund company or a brokerage. Things to look out for include their commission-free options, convenience, and trading costs. I live in the Netherlands and therefore I use DeGiro. DeGiro is the cheapest broker available in the Netherlands.
Choose your index funds. With index funds, various indexes are being tracked. For instance, S&P 500’s index tracks 500 companies. Indexes are chosen based on sector, geography, asset type and more. I will give you some recommendations for index funds in a few seconds.
Start investing! You can wait what you want, you can read books, watch video’s and read more blogs for hours. The most important lesson that I’ve learned is to just start now. In the beginning you will make some mistakes, but the biggest mistake is to not invest at all. By start investing now, you will learn much more about investing. With this blog you will have all the basic information you need to get started. Just start and let the money work for you. In the meanwhile, you can learn more about investing and adjust your strategy as needed.
What are the best index funds to invest in?
Investing in index funds is one thing. Finding the best index funds option is another. There are several index funds out there, so it can be difficult to choose. In my opinion, you should mainly focus on index funds of Vanguard.
Vanguard is the largest provider of index mutual funds in the world. They’ve been in the business of index funds longer than anyone else. Jack Bogle, the founder, created the first index fund in 1976. They have since created a way to passively invest instead of overly relying on mutual fund managers’ decisions.
Some examples of index funds to invest in are:
- Vanguard Total Stock Market ETF (VTI)
- Vanguard Total International Stock ETF (VXUS)
- Vanguard Total World Stock ETF (VT)
- Vanguard FTSE All-World UCITS ETF (VWRL)
- Vanguard S&P 500 ETF (VUSA)
These are one of my favorite index funds. I personally only invest in the Vanguard FTSE All-World UCITS ETF (VWRL). This is because the VTI, VXUS and VT are currently not available in the Netherlands because of European regulations. With a combination of VTI and VXUS my portfolio would be more diversified, so I hope the regulations will change in the future. The VWRL index fund includes 2900 holdings in 47 different countries, so this is a good basic index fund to start with if the other ones are not available, which I think is the case for most of the European countries. The Vanguard S&P 500 ETF is a index fund that I’m not investing in at the moment, but this may change in the future.
If I can recommend just 1 other index fund for stocks, besides Vanguard index funds, it would be the iShares Core MSCI World UCITS ETF (IWDA). This Index fund tracks the MSCI World Index and has a well-diversified portfolio with more than 1600 holdings in 23 different countries.
Besides index funds for stocks you can also invest in index funds for bonds. Good options for investing in bonds are the iShares Euro Aggregate Bond UCITS ETF (IEAG) and iShares Euro Corp Bond UCITS ETF (IEAC). IEAG mainly invest in government, government-related, corporate and securitised bonds, while the IEAC mainly invest in corporate bonds across sectors (industrials, utilities and financial companies).
The VWRL, VUSA, IWDA, IEAG and IEAC index funds are all available via DeGiro and are part of the so-called ‘kernselectie’ (core selection). This means you can do one transaction every month for free in every index fund of the core selection. I only do monthly transactions, so it doesn’t cost me any transaction costs to invest. So a good tip for all the Dutch people who are reading this.
At this point, you should be excited about investing in index funds. It’s okay if the excitement has not kicked in yet. You may want to go over the post a few times to understand all that has been explained.
Remember, if investment gurus like Warren Buffett and Tony Robbins recommend starting out with index funds, then it’s a sure fire way to succeed! Take a bold step today. Invest your money wisely in index funds and enjoy all the benefits that come with it. If you need more advice from me, just ask down below or read my blow about my investment strategy.