Welcome back kids! I am so glad you made it back; this week we are going to be talking about the exciting world of index funds and ETFs (insert oohs and ahhhs here). These are great options for passively investing in the stock market without having to worry in the long run. These investments only take a small amount of research to do but it’s nowhere near as extensive as picking out other investments or single stocks. There are a number of prominent index funds that offer good returns at a low cost. Mr. Nahas, how do I invest in index funds? Don’t worry, I will take you through the ins and outs of it. Before I dive deep into the subject, I want to give you some background information first, so let’s get to work!
Stocks/Stock Market: This is where people or institutions can buy and sell stocks of publicly traded companies. A stock is equity in a company; it represents a piece of ownership. Owning a stock essentially represents you owning a piece of the business. For example, if you a bought share (unit of ownership interest) of Apple, that means you own a portion of the company. The more shares of the company you own, the larger percentage of the company you own and have a stake in. We can go into detail about stocks in a later post!
Indices: The three major US market indices are the Dow Jones Industrial Average (DJIA), Standard and Poor 500 (S&P 500, there are actually 505 companies in here, not 500), and National Association of Securities Dealers Automated Quotations (NASDAQ Composite is the index). So, Mr. Nahas, what is an index? Fantastic question! It’s basically a measure of performance of a certain group of stocks or bonds that are located in these indices. So, for example, I have three groups A, B, and C. I put companies in each of these groups, the performance of all the companies in each group are aggregated and represented as the performance in the index. The S&P 500 is made up of about 75% of the equity market, the NASDAQ is tech-heavy but has other companies as well, and the Dow Jones is made up of the most prominent, well-known companies such as Boeing, IBM, and Coca-Cola. It is important to note that companies can be in multiple indices, such as Johnson and Johnson; they are in the S&P 500 and the Dow Jones. You can’t directly invest in the index but rather buy a fund that tracks the index, and this fund is known as an Exchange-Traded Fund (ETF), but if you are buying an ETF that tracks a major market index such as the S&P 500, people just say index fund. An ETF is often a collection of (fund) securities (stocks and other investments). There are a lot of ETFs available on the market, for example, you can buy an ETF that tracks the performance of the airline industry or the hotel industry, etc. This means that most or all of the airline stocks or hotel stocks are in their respective ETF. It’s a way for you to get exposed to a certain industry without having to choose an individual company to invest in. ETFs are bought and sold just like other stocks.
Now since we got basic information out the way, we can focus on investing in index funds! So, as I mentioned before, you can’t directly invest in the index, you have to choose an ETF that tracks one of the indices. The most popular index that companies track is the S&P 500, it’s a large diversified group of companies that does not expose you to too much risk but at the same time provides you to a stable return on investment. When researching index funds, there are some things to consider:
Here are some of the top index funds, their tickers, and expense ratio (Tickers are a way for you to find the funds on your brokerage account). By no means is this an exhaustive list.
Now once you have your eyes set on which index fund you want to invest in, you must have an account with a licensed brokerage. Mr. Nahas, what is that? The brokerage is kind of like a middleman, you deposit money in the account, which then allows you to buy and sell stocks or other forms of investments if they offer it. The brokerage places the buy and sell orders on your behalf. Different brokerages have different account requirements. Here is a list of things you should look for and research:
After you picked your brokerage and the fund you want to invest in, it’s time to start buying… sort of… Mr. Nahas, what do you mean by sort of? So, kids, I have to lay some ground rules for investing in an ETF that tracks the index.
Let’s imagine that you made a plan to start investing in an index ETF and have $400 saved up to invest right away. You will also contribute $100 every month towards it. In this scenario, let’s say that for the first month, you will invest $500, $400 from the saved-up money and $100 from your monthly contributions. Take that $500, split it into 4 $125 pieces and buy the index ETF on different days of that month. What I am trying to get at is to not spend the $500 right away at one time but rather spread it out over the course of the month, try to do that with the $100. In some cases, you might not be able to do this, it just depends on the price of the ETF. For example, Vanguards ETF (VOO) is $262.45 at the time of writing. In this case, you would either have to find a cheaper index fund (Charles Schwab has one that is $44 at time of writing), invest every three months in this case, or save more money each month. Regardless, just invest in the index ETF and try to buy as often as you can.
I know this is a lot to take in, but this is how you start accumulating wealth passively. This isn’t something you need to stress over if the price went down, especially if you have an S&P 500 index ETF. A time like this is a perfect example, all of the index ETFs are down from their previous highs, which means the prices are cheaper and gives you an opportunity to buy more shares at a cheaper price. If you don’t believe me, then look up what Warren Buffet has to say about this topic. I hope that I answered the question of how to invest in index funds! See you next week kids!