If you’re looking to get started investing in the stock market, investing in Index Funds is one of the easiest ways to get started as a beginner. In fact it’s what Warren Buffet recommends most average investors do.
Back in 2007 Warren Buffet offered up a challenge to the hedge fund industry. He stated that over a 10-year period from 2008 to 2017 Index funds would outperform a handpicked portfolio of hedge funds net of expenses and fees. Ted Seides co founder of Protege Partners LLC took him up on the bet.
Buffet chose a Vanguard S&P 500 Index as his fund of choice, with Ted picking 5 active funds for his portfolio. The results are more shocking than you might expect.
Teds active funds returned 36.3% net of fees over that ten-year period while Buffets S&P 500 Index fund returned 125.8%. That is a massive difference.
If the people who trade the markets for a living can’t beat the market, we probably can’t either.
So, in this article I’m going to explain exactly what an Index Fund is, How to Choose A Good Index Fund to invest in and exactly how to buy your first index fund step by step.
Index Fund Investing For Beginners Video Guide
What Is An Index Fund?
Let’s think about this in terms of music. You can think of an Index Fund like a music playlist that’s designed to represent a particular mood or genre. Just like a playlist containing a variety of songs by different artists, an index fund holds a variety of stocks or bonds from different companies.
When you create a playlist you might select songs based on a certain theme like EDM or Rap. Similarly, an Index Fund is based on a specific market index such as the S&P 500 or the FTSE 100. This index acts as the ‘theme’ of the fund, guiding what stocks or bonds it includes.
Stocks are included in an Index based on pre-determined criteria. Just as playlists are updated with new songs, index funds are regularly updated to include stocks that best represent the market segment they are tracking.
By investing in an Index fund you are investing in a diversified range of stocks spreading your risk across multiple stocks rather than betting on just a few individual ones.
Benefits Of Investing In An Index Fund
There are 4 main benefits to investing in an Index fund over investing in individual stocks. Diversification, Cost Effectiveness, Simplicity and Performance.
Diversification
An Index fund contains a variety of stocks based on the fund you invest in. This variety helps to spread your risk. If one stock doesn’t perform well, others might, balancing out your investment.
Cost Effectiveness
Index funds are often more affordable than buying individual stocks. They typically have lower fees because they’re passively managed. This means more of your money stays invested and working for you.
Simplicity
Investing in index funds is like using a GPS for a road trip. You don’t need to know every turn and road; the GPS guides you. Similarly, with index funds, you don’t need to pick individual stocks or constantly watch the market. The fund follows the market index, making investing simpler for you. Most people don’t want or need to spend hours per week looking at stocks. Index
Performance
Historically, index funds have shown strong long-term performance. While they might not beat the market, they do aim to mirror it. For many investors, especially beginners, keeping up with the market is a solid strategy.
For Example:
If you invested £500 per month in Index Funds and got a 9.9% annual return (which is the 30 year annualized return of the S&P 500 over the last 30 years), you would have £1.1 Million while only investing £180,000 of your own money.
That’s the power of compound returns over long periods of time.
There’s one more thing that also gives you huge compounding returns over time. Subscribing to this channel!
We now know that Index Funds are a good investment vehicle but what should we look for when picking an Index Fund.
How To Find Index Funds That Suits Your Needs
Now you know the benefits of Index funds you need to decide what type of fund you want to invest in.
For me, I like to invest in a global Index fund that holds stocks in all developed markets with a heavy weighting towards the United States.
Most of the global market growth has come out of the United States in the past 10 years and I think it will be similar in next 10 years so I want to have most of my portfolio invested in the United States but also have some exposure to other markets for diversification. I want my wealth to grow as the global market grows as a whole.
Some people prefer to invest solely in the United States or solely in the UK but for most investors I think a good place to start is with a global fund that you plan to hold for a long period of time.
So now we know our objective, to invest in the global stock market with a large weighting towards the United States we can start looking for a fund that meets that criteria.
I like to use the Hargreaves lansdown Index Fund page to find funds that meet my needs.
What To Look For When Picking An Index Fund
There are hundreds of Index Funds available to invest in, so it’s important to choose ones with solid fundamentals. Four things you want to look at before investing are the Fees, Historical Performance and Assets Under Management.
Fees
Index funds have significantly cheaper fees than active funds. Index funds in the UK generally have fees of around 0.07% to 0.2% per year. Most actively managed funds have fees of 1-2% which makes a huge difference in your returns over long periods of time.
This is one of the main reasons Warren Buffets Index fund from the beginning of the video massively outperformed the portfolio of actively managed funds.
Generally for Index Funds you want to keep your expense ratio below 0.2% when investing from the UK. In the US you can find funds with expense ratios as low as 0.03%.
Historical Performance
This is like checking a car’s track record before buying it. Historical performance shows how the fund has done in the past. While past performance isn’t a guarantee of future results, it gives you an idea of how the fund has navigated different market conditions. Understanding a fund’s track record helps you set realistic expectations and choose a fund that aligns with your investment goals.
Assets Under Management
AUM indicates the total market value of all the investment Funds with higher AUM are generally more established and can have lower transaction costs due to economies of scale.
So let’s find a fund that meets our needs..
For me the Fidelity Index World Fund meets all of my goals. It has global exposure in developed markets with 70% allocated towards the United States. It has over 1500 large and mid cap holdings. Fees come in at 0.12%, historical performance is great and the AUM is over £1 Billion.
Now that we have found a fund that meets our criteria we can make our first investment. I’m going to take you through it step by step.
Step by Step Guide To Investing In Index Funds
Picking A Brokerage
First you need to pick a brokerage where you can buy the Index Funds of your choice. Index funds are unique as they are not listed on the stock market. You an buy them direct from the fund provider or purchase them on some brokerage platforms.
For example, if you want to invest in the Fidelity Fund we identified previously, you can go directly to the Fidelity website, create an account and purchase the fund.
When you invest through the fund provider there are usually account fees on top of the annual fund charge. Fidelity typically charge 0.35% service fee on your account however if you have a large account balance there are discounts available.
However, in the UK I like to personally buy my Index Funds through Hargreaves Lansdown. On their platform you can purchase funds from many different providers so if you want to hold multiple funds from different providers you can do it all under one account. This makes things much easier to manage.
Hargreaves Lansdown charge 0.45% per year on funds up to £250,000, so it is slightly more expensive but I’m personally willing to pay it for the ability to have all my investments under one roof.
I have also used HL for 7-8 years and their customer service has always been great.
Hargreaves Lansdown is one of the most trusted investment platforms in the UK. They offer amazing customer service with access to someone on the phone at any time. However, these come at a high price in terms of fees.
- Amazing customer service
- Reliable trustworthy brand name
- High fees on stock trading & ETFs
- Less Modern interface than competitors
Picking An Account
Once you have decided on the broker you are going to use you will have to decide which type of account to set up.
With Hargreaves Lansdown you will have 3 choices:
- General Investment Account
- ISA
- Self Invested Personal Pension
A general account is a standard account that let’s you buy and sell funds and shares. However, in a general account you have no tax benefits and will have to pay tax on any capital gains or dividends over your annual allowances.
Many new investors don’t know about the benefits of investing through an ISA or a SIPP.
Currently a Stocks and Shares ISA allows investors to invest up to £20,000 per year. Any gains or dividends made in this account are tax free. If you let your money compound for decades this could save you 100s of thousands in tax.
SIPPs also have tax benefits. The government will top up your contribution. For every £100 you add to your SIPP the government will add an extra £25. However with pensions you are unable to withdraw the money until you reach the minimum pension age. Your money can grow tax free while in your Pension but you will be taxed income tax when withdrawing from the pension.
Personally I invest through an ISA as it shelters my money from tax and I have the freedom to use the money at any time if I need to.
Once you have created your account of choice, it’s time to make your first investment. Let’s show you exactly how it works.
Making Your First Investment
In Hargeaves Lansdown, log in and access your account. In the top right there is a search function where you can search for the Index Fund you want to invest in. Search for the fund and click on it.
On the fund overview page click on ‘Invest Now’.
Here you can select Buy and decide how much you want to invest in this specific fund. Click on continue.
You will then see an overview of your order. To confirm and purchase your shares click on “Place a deal now”.
Your purchase will sit in pending until it is purchased on the next trading day. You will then be able to view and track your funds performance inside your account.
How Much Do You Need To Invest
Many people think you need thousands of pounds to get started investing but that’s simply not true.
With Index funds there sometimes can be a minimum investment depending on the platform you invest with. On Vanguard the minimum single investment is £500 or £100 monthly contribution.
On Hargreaves Lansdown you can invest in Index funds with as little as £100.
If you’re young I would highly recommend just getting started investing. Even just £100 per month can turn into huge sums of money over long periods of time. If you invest £100 per month from 20 to 65 and get a 10% average rate of return you would end up with over £1,048,250 at retirement.
Final Thoughts
That’s it. That is my full guide to investing in Index Funds. Hopefully you learnt something along the way and can now get started on your own investing journey.
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