Investing Basics: Why Many Beginners Start with Index Funds
Investing can seem complicated, but one of the most widely recommended approaches for beginners is also one of the simplest: low-cost index funds.
What is an index fund?
An index fund is a mutual fund or exchange-traded fund (ETF) that tracks a market index, such as the S&P 500 or a total stock market index. Instead of trying to pick winners, it owns the whole basket of companies in the index.
Why beginners like them
- Built-in diversification: One fund can hold hundreds or thousands of companies, so a single company's trouble has limited impact.
- Low costs: Many broad index funds charge expense ratios below 0.10% a year. Over decades, low fees can add up to tens of thousands of dollars in savings.
- Simplicity: You do not need to research individual stocks.
The power of time
Compounding means your returns earn returns. Someone who invests $200 a month for 30 years at a hypothetical 7% average annual return would end up with about $244,000, even though they contributed only $72,000. Returns are never guaranteed, and markets can fall sharply in any given year, which is why investing is best for money you will not need for at least five years.
Where to hold your investments
Tax-advantaged accounts are usually the first stop. If your employer offers a 401(k) match, contributing enough to get the full match is often called free money. Individual retirement accounts (IRAs) are another option. After those, a regular taxable brokerage account offers flexibility.
Before you invest
Most financial educators suggest first having an emergency fund and paying off high-interest debt. Paying off a credit card charging 24% is a guaranteed return that the stock market cannot promise.
This article is educational and is not personalized investment advice. Consider speaking with a licensed financial professional about your situation.