The Best Index Funds and How to Start Investing

If you’re new to investing, you may have heard of index funds — but you may not be sure exactly what they are, how they work, or how to invest in them.

Index funds are a popular investment option for beginners and veterans alike. They offer a low-cost way to invest in a diversified portfolio of stocks and bonds.

In this article, we’ll explain what index funds are, how they work, and the advantages and disadvantages of investing in them. We’ll also share our top picks for the best index funds.

What is an index fund?

An index fund is a type of mutual fund that invests in a basket of stocks that are within a specific index. These funds are a type of passively managed fund, meaning the goal is to match the performance of the index they track, rather than try to beat the market.

Index funds are a popular choice for new investors because they are diversified, low-cost, and easy to understand. In fact, many financial experts recommend that the bulk of your investment portfolio should be made up of index funds.

Index funds vs. mutual funds

Index funds and mutual funds are similar in that they are both baskets of stocks, bonds, or other investments. However, there are some important differences between the two.

For one thing, mutual funds can be actively managed or passively managed. An actively managed mutual fund has a portfolio manager who makes buy and sell decisions with the goal of outperforming the market. On the other hand, passively managed mutual funds are designed to track the performance of a particular index, just like index funds.

The most important difference has to do with how you buy and sell your shares. An index fund is an exchange-traded fund (ETF), which means that it trades just like a stock. You can buy and sell shares of an index fund at any time during market hours, and the price you’ll pay is based on the ETF’s net asset value (NAV) at that time.

Mutual funds, on the other hand, are bought and sold at the end of the trading day. When you buy shares of a mutual fund, you’ll get the next day’s closing NAV. When you sell shares, you’ll get the NAV at the end of that trading day. This is a key difference between the two types of funds, and it’s one of the reasons index funds are generally a better choice for long-term investors.

What are the benefits of index funds?

Index funds offer a number of benefits, especially for new investors. Here are a few to consider.

Low cost

One of the most important advantages of index funds is that they tend to have low expense ratios. This is the percentage of your investment that goes toward the fund’s operating costs.

Most mutual funds have expense ratios that are higher than 1% of your investment. By contrast, the average index fund has an expense ratio of just 0.09%.

It may not seem like a big difference, but over time, the lower fees of index funds can add up to thousands of dollars in savings.

Diversification

Another key advantage of index funds is that they offer instant diversification. When you buy shares of an index fund, you’re investing in all of the stocks in that index.

For example, when you buy shares of an S&P 500 index fund, you’re getting exposure to 500 of the largest companies in the U.S. economy. This helps you spread your risk out across many different companies.

If you were to invest in individual stocks instead, you’d have to put a lot more money up to get the same level of diversification.

Passive management

Index funds are passively managed, which means the fund’s managers aren’t trying to pick the best stocks. Instead, they simply aim to match the performance of the index the fund is tracking.

By contrast, actively managed funds have teams of managers who are constantly buying and selling stocks in an effort to beat the market. However, research has shown that very few actively managed funds are able to consistently outperform the market.

As a result, index funds are a great way to make sure you get the market’s return.

What are the drawbacks of index funds?

Index funds are a great investment option for most people, but they're not perfect. Here are a few potential drawbacks to consider:

• Not much potential for outperformance: Index funds are designed to match the performance of the index they track, not to beat it. This means that your investment's upside potential is limited to the index's return. For example, if you invest in an S&P 500 index fund, your returns will be very similar to the S&P 500's, but you won't beat the market.

• Not all index funds are created equal: While index funds are designed to track an index, they can do so with varying degrees of success. An S&P 500 index fund and a total stock market index fund are designed to track the same benchmark, but there are differences in how they do so. For example, the S&P 500 is made up of 500 of the largest U.S. companies, while a total stock market index fund includes those 500 companies and all the rest of the U.S. stocks as well. This means that the total stock market index fund is more diversified than an S&P 500 index fund, which can be a good thing. However, the total stock market index fund may have a slightly different performance than the S&P 500, which could be a good or a bad thing. Make sure to understand the index your fund is tracking and how it is doing so.

• Costs: Index funds are typically low-cost investments, but they're not free. Even if an index fund charges just 0.10% per year, that's $10 for every $10,000 you have invested. On the other hand, a higher-cost mutual fund might charge 1% or more. While this may not sound like a big difference, the impact of fees on your investment returns can be substantial over time. If you're investing in a taxable brokerage account, consider the tax efficiency of an index fund. Most of the time, index funds are more tax-efficient than actively managed funds, but there are some exceptions.

• Limited downside protection: While index funds are designed to track the performance of a particular index, they also expose you to the full downside risk of that index. For example, if you invest in an S&P 500 index fund, you'll experience the same losses as the S&P 500 in the event of a market downturn. This may not be a big deal if you have a long time horizon and can afford to ride out the ups and downs of the market, but it's something to be aware of.

How do you buy an index fund?

You can buy an index fund through any brokerage account or through a robo-advisor. Some robo-advisors, like SoFi Invest, offer commission-free index funds. With a brokerage account, you can purchase index funds through exchange-traded funds (ETFs) or mutual funds.

When you’re researching index funds, you’ll want to look at the expense ratio, which is the amount of money you’ll pay each year to own the fund. You want to keep this number as low as possible, because it eats into your returns. A good rule of thumb is to look for index funds with an expense ratio below 0.50%.

You’ll also want to look at the minimum investment for the fund. Some index funds have a minimum investment of $3,000 or more, which can be a barrier for beginner investors.

The 11 best index funds to buy for low fees

Index funds can be a low-cost, simple way to get broad exposure to a particular segment of the stock market. Some of the most popular index funds track the S&P 500, a stock index that tracks the 500 largest publicly traded companies in the U.S. And while there are more than 2,000 index funds available to investors, here are 11 of the best index funds to buy now.

1. Vanguard Total Stock Market ETF (VTI)

The Vanguard Total Stock Market ETF (VTI) is one of the most popular ways to get exposure to the U.S. stock market. This index fund aims to track the performance of the CRSP US Total Market Index, which covers more than 3,500 companies of varying sizes. The fund is market-cap weighted, so it holds the largest companies in the index, like Apple, Microsoft and Amazon, in the highest proportions.

2. Vanguard S&P 500 ETF (VOO)

The Vanguard S&P 500 ETF (VOO) is a great option for investors who want to focus on the largest U.S. companies. This index fund aims to track the performance of the S&P 500, which is made up of the 500 largest publicly traded companies in the U.S. The fund is market-cap weighted, so it holds the largest companies in the index, like Apple, Microsoft and Amazon, in the highest proportions.

3. Schwab U.S. Large-Cap Growth ETF (SCHG)

The Schwab U.S. Large-Cap Growth ETF (SCHG) is a great option for investors who want to focus on large-cap growth stocks. This index fund aims to track the performance of the Dow Jones U.S. Large-Cap Growth Total Stock Market Index. The fund is market-cap weighted, so it holds the largest companies in the index, like Apple, Microsoft and Amazon, in the highest proportions.

4. Schwab U.S. Large-Cap Value ETF (SCHV)

The Schwab U.S. Large-Cap Value ETF (SCHV) is a great option for investors who want to focus on large-cap value stocks. This index fund aims to track the performance of the Dow Jones U.S. Large-Cap Value Total Stock Market Index. The fund is market-cap weighted, so it holds the largest companies in the index, like Apple, Microsoft and Amazon, in the highest proportions.

5. Vanguard Small-Cap ETF (VB)

The Vanguard Small-Cap ETF (VB) is a great option for investors who want to focus on small-cap stocks. This index fund aims to track the performance of the CRSP US Small Cap Index, which covers more than 1,500 small-cap companies. The fund is market-cap weighted, so it holds the largest companies in the index, like Apple, Microsoft and Amazon, in the highest proportions.

6. Vanguard FTSE All-World ex-US ETF (VEU)

The Vanguard FTSE All-World ex-US ETF (VEU) is a great option for investors who want to focus on international stocks. This index fund aims to track the performance of the FTSE All-World ex-US Index, which covers more than 3,000 companies of varying sizes. The fund is market-cap weighted, so it holds the largest companies in the index, like Tencent Holdings, Alibaba and Nestle, in the highest proportions.

7. Vanguard Total International Stock ETF (VXUS)

The Vanguard Total International Stock ETF (VXUS) is another great option for investors who want to focus on international stocks. This index fund aims to track the performance of the FTSE Global All Cap ex US Index, which covers more than 7,000 companies of varying sizes. The fund is market-cap weighted, so it holds the largest companies in the index, like Tencent Holdings, Alibaba and Nestle, in the highest proportions.

8. Vanguard Real Estate ETF (VNQ)

The Vanguard Real Estate ETF (VNQ) is a great option for investors who want to focus on real estate investment trusts (REITs). This index fund aims to track the performance of the MSCI US Investable Market Real Estate 25/50 Index, which covers more than 180 REITs. The fund is market-cap weighted, so it holds the largest companies in the index, like American Tower, Prologis and Crown Castle, in the highest proportions.

9. Vanguard Consumer Discretionary ETF (VCR)

The Vanguard Consumer Discretionary ETF (VCR) is a great option for investors who want to focus on consumer discretionary stocks. This index fund aims to track the performance of the MSCI US Investable Market Consumer Discretionary 25/50 Index, which covers more than 170 consumer discretionary companies. The fund is market-cap weighted, so it holds the largest companies in the index, like Amazon, Tesla and Home Depot, in the highest proportions.

10. Vanguard Information Technology

1. Vanguard Total Stock Market Index Fund (VTSAX)

If you want to invest in the U.S. stock market and not have to worry about picking individual stocks, the Vanguard Total Stock Market Index Fund is a smart choice. As the name implies, this fund is designed to give investors exposure to the entire U.S. stock market.

The fund's benchmark index is the CRSP US Total Market Index, which includes just about every stock that's publicly traded in the U.S., including large-, mid-, small-, and micro-cap stocks. As of the end of 2020, the fund had an impressive 3,557 stock holdings.

VTSAX has a very low expense ratio of just 0.04%, which means that if you invest $1,000 in this fund, you'll pay just 40 cents per year in fees. In addition, the fund has historically done a good job of tracking its benchmark index, so investors can be confident that they're getting the market-like returns they're looking for.

2. Vanguard 500 Index Fund (VFIAX)

The Vanguard 500 Index Fund (VFIAX) is the best index fund for passive investors who want exposure to the stock market as a whole. That’s because it’s designed to track the S&P 500, which is an index of the 500 largest publicly traded companies in the U.S.

The S&P 500 is a market-capitalization-weighted index, which means larger companies have more of an impact on the fund’s returns. This allows the fund to capture the performance of the stock market as a whole, and the S&P 500’s long-term average annual return of about 10% is a good proxy for what investors can expect from this fund over time.

3. Fidelity Total Market Index Fund (FSKAX)

Fidelity is another brokerage that offers a wide variety of index funds, and the Fidelity Total Market Index Fund is one of the best. This fund is designed to track the performance of the entire U.S. stock market, as represented by the Fidelity U.S. Total Investable Market Index.

The fund has more than 3,700 stocks in its portfolio, and the top 10 holdings represent just over 20% of the total assets. The Fidelity Total Market Index Fund has an extremely low 0.015% expense ratio, which makes it one of the lowest-cost funds on the market.

One of the best things about this fund is that it can be purchased with no commission when you invest through Fidelity. This can make it a particularly good choice if you plan to invest small amounts of money at regular intervals.

4. Schwab Total Stock Market Index Fund (SWTSX)

Schwab's Total Stock Market Index Fund is another good option for investors who want to invest in the entire U.S. stock market. Like the Vanguard fund, Schwab's version includes large-cap, mid-cap, small-cap, and even micro-cap stocks.

The main difference between the two is the fact that Schwab's fund has a slightly lower expense ratio and a lower minimum investment requirement. While the Vanguard fund has a $3,000 minimum, Schwab's fund can be invested in for as little as $1.

In a nutshell, Schwab's Total Stock Market Index Fund is a great way to invest in the entire U.S. stock market with a minimal investment.

5. iShares Core S&P 500 ETF (IVV)

The iShares Core S&P 500 ETF is the second S&P 500 index fund on our list, and it is a great option to consider. This fund is very similar to the SPDR fund mentioned above, with a few small differences.

For starters, the iShares S&P 500 ETF charges a 0.03% annual expense ratio, which is the lowest of any S&P 500 index fund. So, if you want to invest in the S&P 500 and want to keep costs as low as possible, this is a great fund to consider.

The biggest difference between the two funds is that the iShares S&P 500 ETF is a share class of the iShares S&P 500 Index Fund, which is a mutual fund with a $2,000 minimum initial investment. The ETF share class is identical to the mutual fund and has no minimum investment requirement.

6. Vanguard Total Bond Market Index Fund (VBTLX)

If you’re looking to add some bond exposure to your investment portfolio, the Vanguard Total Bond Market Index Fund (VBTLX) is a great way to do it. This fund is designed to track the performance of the Bloomberg Barclays U.S. Aggregate Float Adjusted Index, which is a broad bond index that includes U.S. government, corporate, and mortgage-backed securities.

The average credit quality of the bonds in this index is quite high, and the fund has an average duration of 6.1 years. This makes it a good choice for investors who want a moderate level of risk in their bond portfolio.

The fund’s expense ratio is 0.05%, and the minimum initial investment is $3,000. There are also ETF shares of this fund available, which have the same investment objective and portfolio but have a lower $1 minimum investment. The ticker symbol for the ETF shares is BND.

7. Vanguard S&P 500 ETF (VOO)

The Vanguard S&P 500 ETF (VOO) is a great way to invest in the S&P 500, which is a stock market index that measures the stock performance of 500 of the largest companies listed on stock exchanges in the United States.

The VOO index fund is a type of exchange-traded fund, or ETF, that tracks the S&P 500 Index. The S&P 500 index fund is a fantastic way for beginning investors to get started in the stock market, because it provides significant, broad-based exposure to the stock market.

In fact, the S&P 500 has historically returned 9-10% per year. The VOO fund charges a 0.03% expense ratio, which is one of the lowest in the industry. This means that it costs just $3 per year for every $10,000 you have invested.

8. Fidelity 500 Index Fund (FXAIX)

The Fidelity 500 Index Fund (NASDAQMUTFUND: FXAIX) is an S&P 500 index fund, meaning it gives investors exposure to the 500 largest companies in the U.S. The S&P 500 is a market capitalization-weighted index, so the fund is more heavily invested in the largest companies. As of the end of 2020, the 10 largest holdings accounted for 28% of the fund's assets.

The Fidelity 500 Index Fund is a great way to get exposure to the stock market as a whole, and is an excellent choice for long-term investors who want to keep things simple. The fund has a very low 0.015% expense ratio, making it one of the lowest-cost ways to invest in the S&P 500.

9. Vanguard Total International Stock Index Fund (VTIAX)

If you want to invest in stocks, but you want to diversify your investment portfolio beyond U.S. companies, you can invest in international stocks. The Vanguard Total International Stock Index Fund (VTIAX) gives you exposure to thousands of stocks from companies in developed and emerging international markets.

The fund’s expense ratio is 0.11%, and the minimum investment is $3,000. This fund has a 10-year return on investment of 5.87%. If you want to invest in international stocks, but you don’t have $3,000 to invest, you can invest in the Vanguard Total International Stock ETF (VXUS) instead. This is the exchange-traded fund (ETF) version of the mutual fund.

10. Vanguard Total Stock Market ETF (VTI)

If you’re looking for a stock index fund that covers the entire U.S. stock market, the Vanguard Total Stock Market ETF (VTI) is an excellent choice. This fund seeks to track the performance of the CRSP U.S. Total Market Index, which includes essentially every publicly traded stock in the U.S.

The fund is heavily weighted toward large-cap stocks, but it also has significant exposure to mid-cap and small-cap stocks. This makes it a great way to get broad stock market exposure in a single investment.

The Vanguard Total Stock Market ETF has an extremely low 0.03% expense ratio, making it one of the lowest-cost ways to invest in the entire stock market.

11. Schwab International Index Fund (SWISX)

If you want to invest in international stocks, Schwab International Index Fund is an excellent way to do it. This fund invests in stocks of companies in developed countries outside the United States and is designed to track the performance of the FTSE Developed ex-US Index.

The fund has a low expense ratio of 0.06% and is well-diversified, with 1,366 stocks in its portfolio. Top country allocations include Japan, the United Kingdom, and France, and the top sector is financials.

The bottom line

Investing in index funds is a great way to get started in the stock market. They’re easy to buy and sell, and they’re already diversified, so you don’t have to worry about picking individual stocks.

The funds we’ve listed here are some of the best in their categories, but they’re not your only options. There are thousands of different index funds to choose from, and they all have different fees and investment minimums.

Before you invest, consider how much you want to invest, how long you want to invest for, and what your risk tolerance is. Then, do your research and find the funds that best fit your investment goals.

Conclusion

The best time to start investing was yesterday, but the second-best time is today. If you have a 401(k) through your employer, you can start investing in index funds right away. If you want to start investing outside of your 401(k), you can open an individual retirement account (IRA) or brokerage account through a robo-advisor or online brokerage.