We are all looking for an easy way to grow our money, but there are so many different and complicated methods that it can be overwhelming. If only there was an easy way to invest your money into the stock market without having to worry about if you’re making the right choice. Well what if I told you there was a way? What if I told you that index fund investing provides a simple, easy way to grow your money? In this article we are going to cover:
- What is index fund investing?
- How do you do it?
- What are the advantages and disadvantages?
- How do I get started?
So let’s dig into it!
What is Index Fund Investing?
First, let’s start with what index funds are.
What are Index Funds?
Index funds are a type of exchange traded funds (ETFs) that track a particular market index (e.g. S&P500). ETFs can be bought or sold on on a stock exchange just like a stock can, but when you buy an ETF, you’re buying a basket of stocks, rather than a single one. What this means is that by buying a single ETF/index fund, you can very quickly diversify.
When you purchase tand index fund, you own a portion of all of the companies that the index tracks. As the index changes and companies are added or removed, the fund will also need to be updated. The fund manager isn’t picking individual stocks and trying to time the market, but rather just mirroring the index the fund is tracking. As a result, the management fees on the index fund can be extremely low compared to mutual funds (0.05%-0.5% for index funds vs. 1-3% for mutual funds). This couple percent in savings can compound over your life to have a huge effect on the growth.
What is Index Fund Investing?
Index fund investing is a strategy where you have a large part or all of your investment portfolio in one or more index funds, and you hold them forever. Because you are purchasing funds that track an index, you’re essentially betting on the market, meaning that if the market goes up, you make money. And because the fund is being rebalanced as the indices change, the effort on your end is extremely low.
How Do You Do It?
To start index fund investing, there is a little bit of upfront work, then there can be some work on a semi-regular basis to rebalance depending on how you’ve got your account set up.
Upfront Work
When getting started with index fund investing, there are three things you need to do: set up a self-directed investing account, determine how you want to allocate your account, and find the funds that fit each allocation.
Setting Up a Self-Directed Account
Setting up a self-directed account is a little more involved than opening up say a savings account, but it’s still pretty easy. Here in Canada, the most popular are Questrade, or WealthSimple. I personally use Questrade, and have had a great experience with it over the last few years. I would also encourage you to take advantage of Canadian registered accounts to save on taxes. If you’re in another country, you’ll have to see what banks and accounts are available in your region.
Determining Allocations
The second step is defining how you want to allocate your funds. What I mean by this is determining what percentage of your account value you want to put into bonds, Canadian stocks, U.S. stocks, international stocks, etc. There is no right way to do this, and it really depends on your particular risk appetite and what economies you believe will thrive. There are also single funds that do this balance for you (Target-Date Funds), and you just select the year you plan to retire and put all your money in that fund.
That said, here is my personal account allocation:
- Bonds – 20%
- S&P 500 – 50%
- TSX – 15%
- International Stocks – 15%
I’ve got a lot of time before retirement, and wanted a wide breadth of exposure. I also wanted the relative safety of bonds. This could serve as a good starting point to get you moving.
Finding Funds For Each Allocation
Once you’ve determined how you’re going to allocate your account, you need to pick funds to fill those needs. Here are some key things to look for:
- Low Managemenent Expense Ratio (MER) – The MER represents the management fee for the issuing organization to put the fund together. For index funds this should be very very low. For example, an S&P500 index fund should be in the realm of 0.05% to 0.15%, meaning that on $10,000 invested you’ll pay $5 to $15 annually. For international funds this may be a bit higher (up to 0.5%) as there’s a bit more active management that goes into these.
- Issued by a Organization in Your Country – In Canada, if you are using a tax-advantaged account for investing and you receive a dividend from an american security you will pay a 15% withholding tax. Make sure it’s provided by a Canadian bank (e.g. BMO) to avoid this witholding tax
- How Closely It Follows The Index – When investing in a fund that matches a particular index (e.g. S&P500), you want to see how closely it matches the performance of the index. This is often reported on in the issuing organization’s information page.
Once you’ve got that all figured out, you’re ready to purchase the funds using your self-directed account!
Ongoing Work
One of the beauties of index fund investing is that it’s so easy. The only ongoing work for managing your account is the occasional rebalance. The different funds in your account won’t fluctuate at the same rates, so you may find the percentage allocated to each fund changes from your initial alllocation. About once a year you can review and sell/buy to return it to your desired allocation. You can also update your allocations as you age, for example putting more money into bonds as you near retirement.
What are the Advantages and Disadvantages
As with anything, index fund investing has advantages and disadvantages:
Advantages
- Low MER – Compared to other funds (e.g. mutual funds) the MERs are incredibly low. This means that you keep more of your money and leting it compound into greater wealth.
- Easy – The upfront work is pretty minimal, and the ongoing management is easy and infrequent.
- Low Stress – You can sleep easy knowing that your money is being put to work, and not worry about making difficult investing decisions.
- Frees Up Your Time for Other Activities – Because you don’t have to spend time worrying about your investments, you can instead spend that time in other pursuits. This could be fitness related, relationship related, or investing time in other money-making activities such as advancing your career or pursuing side hustles.
In my eyes, index fund investing is as close as you’ll get to truly passive income. You can stop worrying about your investments and put more energy into other parts of your life.
Disadvantages
- Boring – Index fund investing is not going to provide you any excitement. But I would say investing should be pretty boring, and you should get excitement in other parts of your life. That said, if you’re looking for more excitement from the stock market, check out some other strategies.
- Not Going to Beat The Market – Because index funds follow the indices, you’re never going to do better than them. You are going to get average returns. That said, you can free up your time to make more money in other ways to increase the amount you can invest.
How do I get Started with Index Fund Investing?
Now that you have the necessary info, I urge you to get started. Don’t fall into analysis paralysis. Get yourself 85% of the way there, take a step and adjust as you go. So now, go open your account, decide your allocation, and pick funds. It’s really easy to adjust later on, but you’ll never get back the lost time!
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