Index funds are a great investment strategy for beginners. They are easy, low cost, and allow you to quickly diversify. But how much do you need to get started with index funds?
In general, the minimum investment for an index fund is one share of the Exchange Traded Fund (ETF). Index funds typically trade like stocks (unlike mutual funds), so just like purchasing a stock of a company, you need to have at least the trading price of the index fund ETF.
There are other considerations when getting started, brokerage account minimum amounts, including index fund fees, and trading fees.
How Much Money Do You Need to Invest In Index Funds?
To purchase an index fund, you’ll need to be able to purchase at least one share of the ETF.
These ETF prices can range anywhere from $10-$20 to $100s of dollars per share. If you’re getting started with not a lot of money, the decision of what index fund to purchase may be made for you by the price of the ETF. But as you build your investing account, you should make sure you’re purchasing index funds with low management expense ratios (MER).
Now to actually purchase index fund ETFs, there may be a minimum amount to open an account. You’ll need to open a self-directed brokerage account. Be careful to open a self-directed investing account, rather than purchasing mutual funds. The minimum amount depends on the bank. For Canadians, here are a few options (see here for U.S. investors):
- Questrade – $1,000
- BMO Investorline – No minimum
- Wealthsimple Trade – No minimum
- National Bank Direct Investing – $1,000
- TD Direct Investing – No minimum, but fees if the balance is below $15,000
When you start investing, the minimum amount may make your brokerage decision for you. But again, after you’ve built up some savings you should examine the brokerages trading and account fees to find the best option for you.
What are ETFs?
Exchange Traded Funds (ETFs) are essentially shares of a investment fund.
The investment fund represents a pool of money that invests in a number of companies. By purchasing one share of the ETF, you’re purchasing a portion of each of the companies the fund owns.
There are many different flavours of ETFs. There are index funds, for which the holdings match the index it’s tracking (e.g. match the S&P 500). There are industry funds, which hold a series of stocks within a specific industry (e.g. banks). There are also ones for commodities, currencies, specialty (leveraged or inverse), and more.
To curate and manage the holdings of the ETFs, there are fees associated with the ETF. Index funds are typically the cheapest, as the stock selection is automatic (and follows the index). The other types (e.g. industry) will typically have higher fees as there are fund managers who are doing research and making decisions on what companies to hold.
Before investing in any ETF, make sure you review the holdings, understand the strategy, and are aware of the fees.
Costs Associated with Index Fund Investing
If you purchase and own index funds, the two main costs to be aware of are trading/transaction fees, and the management expense ratio (MER).
When purchasing any stocks, ETFs, bonds, options, etc., your brokerage may charge a fee for executing the transaction. The fees will differ by the asset class. For example, with Questrade when buying or selling stocks you’ll pay 1 cent per share, with a minimum of $4.95 and a maximum of $9.95. Whereas purchasing ETFs (index funds included), there’s no fee to purchase, but the selling fee is the same as stocks.
As an index fund investor, you’re typically buying and holding, so the transaction fees will be minimal. That said, it’s worthwhile to review them when selecting a brokerage.
The other fee to be aware of is the management expense ratio (MER). The MER represents the annual fees you’ll pay on your index fund investment. This fee covers the issuing companies expenses to run the fund, things like administrative costs, overhead, etc. With index funds, this is typically really low, ranging from 0.05% to 0.15%. This means that on an investment of $10,000, you’ll pay $5 to $15 in fees.
Actively managed funds (e.g. mutual funds or actively managed ETFs) will have a much higher MER (in the 1-2% range). This is because alongside the general administrative costs, they also have to pay for the research and decision making on holdings. This doesn’t exist for index funds, as it just matches the index it’s tracking.
What are the Benefits Of Investing in Index Funds?
Index funds are a great passive investment strategy for the following reasons:
Low-Cost
Index fund MERs are extremely low (0.05%-0.15%), meaning you keep more of your money. As well, since it’s a buy and hold strategy, your transaction/trading fees are minimized.
Quick Diversification
By purchasing an index fund, you’re purchasing all the stocks in that index. That allows you to quickly spread your investment across a number of companies.
Simple and Easy
Once you’ve decided on your investment allocation, index fund investing takes minimal work. There’s no research or timing the market necessary. You just purchase and let your money grow.
What are the Disadvantages of Investing in Index Funds?
Though index fund investing is a great strategy, there are some disadvantages:
Average Returns
Because the index funds track the index, you’ll never beat the market. You’ll only ever match it.
Boring
Index fund investing is boring compared to active trading strategies. There is minimal active involvement.
Limited Control Over Holdings
Because you’re matching the index, you don’t have as much control over the individual holdings in your account. You may end up holding stocks you don’t want and not holding ones you do.
Summary
Index funds are a great way to get started investing, and you can get started without much capital.
When getting started, think about the brokerage account minimum, the price of the index fund ETF, and any fees associated with the brokerage account or fund.
Investing returns only get better with time, so getting started with a little will help you build the wealth you want.