Stock index funds are mutual funds that invest in companies that are part of a specific index like the Standard & Poor’s 500, the Russell 2000 Index or indexes based on company size or industry. Fund managers pick stocks that represent the index and try to match its performance. Index funds don't have to spend a lot of money researching individual companies, so you usually pay lower fees than other mutual funds charge.
Compare the return you get from different stock index funds. Even though two funds might be similar, they won't have the same performance record. For example, two “small-cap” funds might be based on different indexes of small company stocks and give you different rates of return. You can find the performance history for an index fund in the fund prospectus. This is a document required by the Securities and Exchange Commission and is usually available for free on the fund’s website.
Read the fee and expense information in the fund prospectus. The most important number is the expense ratio, which tells you the percentage of the fund’s assets spent to cover operating expenses each year. Typically, index fund expense ratios range from 0.5 to 2 percent, according to Money-Zine. Think about choosing a no-load fund. No-load funds do not charge a sales commission, so more of your investment dollars go toward buying shares.
Evaluate the tax consequences of investing in a particular index fund. When an index fund sells a stock in its portfolio, any capital gains tax liability is “passed through” to investors. An Index fund that tends to sell stock frequently will leave you owing more capital gains tax than one that has low investment turnover.
Choose a stock index fund that promotes your financial goals. For example, some funds are based on indexes of growth stock, so they’ll help you increase your equity. Others invest in indexes of companies that pay high dividends. These funds are good if you want an investment that yields steady income.
Open an account with the stock index fund you select. You can usually set up your account online by completing an application form on the fund's website. If you'd rather open the account by mail or with a phone call, the website is where you'll find instructions for doing so. You have to provide your name, Social Security number and personal contact information. If you want to invest by electronic funds transfer, you may also need to give your checking or savings account information.
- You can buy shares in index funds through a brokerage firm. If you do, the broker will charge you a fee. You will save money by cutting out the middleman and buying shares directly from the index fund.
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