Index funds are the best way to instantly diversify your investing portfolio. Rather than hand-picking individual stocks, index funds are your gateway to many different stocks, bonds, and other types of securities, all at once.
But not all index funds cost the same. An expense ratio is the cost you pay to manage your account. The higher the expense ratio, the more you’re paying to have that fund managed.
Rather than pay more than you need to, find an index fund with the lowest expense ratio. Here’s how to find them and to see which ones are best for your portfolio.
What Are Index Funds?
Index funds are baskets of securities that track a specific index, like the S&P 500 or the total U.S. stock market. Index funds can be mutual funds or exchange-traded funds (ETFs).
Index funds are considered passive investing, where you try to match a benchmark’s performance. Active investing, on the other hand, is when investors pick individual stocks or funds in an attempt to beat the market. Most of the time, according to research, passive investing wins out.
Why Are Index Funds So Popular?
If you want to invest without putting in a lot of extra work, index funds are the best way to get involved.
“Index funds save investors costs, time, and the effort of actively managing their portfolio,” says Emily Cozad, a portfolio analyst for Buckingham Advisors. “Index funds give an investor exposure to each of the holdings within a specified index without having to purchase each one separately.”
Index funds are a great investment choice that don’t have a lot of overhead, says Jordan Hanson, a CFP and financial advisor at HCR Wealth Advisors
“Index funds are popular because they provide instant, broad diversification at a very low cost,” Hanson says. “Index funds have seen their popularity increase tremendously over recent years as actively managed mutual funds and exchange-traded funds have continued to underperform.”
What Is a Good Expense Ratio?
Expense ratios are what you pay someone else — whether that’s a person or firm — to manage the fund. Expenses include portfolio management, administration, and other related costs.
If you want the best index funds, find the ones that don’t require too much extra expenses on your part. But you’ll need to do your research first.
It’s usually an annual percentage of the total amount you invest in the fund. For instance, a 0.5% expense ratio on $10,000 is $50. On $100,000, it’s $500. A good rule of thumb is anything under .2% is considered a low fee and anything over 1% is high, according to many experts.
“Expense ratios directly impact the return of the fund to the shareholder, so funds with extremely high expense ratios should be considered carefully,” Cozad says, adding that a good expense ratio depends if it’s actively or passively managed.
“A good expense ratio is anything below 0.20%, which is the current average,” Hanson says. “With respect to index funds, a good expense ratio is even lower, anything less than .05%. There are now even funds with no expense ratios.”
5 Best Index Funds With Low Expense Ratios
Good expense ratios are the lowest ones. The less extra fees you pay, the higher your net returns. Here are some of the best low-cost index funds because of their low expense ratios.
- Schwab S&P 500 Index Fund (SWPPX). Expense ratio: 0.02%
- Vanguard S&P 500 ETF (VOO). Expense ratio: 0.03%
- Fidelity ZERO Large Cap Index (FNILX). Expense ratio: 0%
- Fidelity 500 Index Fund (FXAIX): Expense ratio. 0.015%
- Vanguard Value Index Fund Investor Shares (VVIAX). Expense ratio: 0.05%
“All these funds also have extremely low expense ratios which gives investors more of the total return to keep for themselves,” Hanson says.
Index Funds FAQs
Are index funds safe investments?
While all investments carry some sort of risk, index funds are less risky compared to actively managed stocks.
Because an index fund gives the investor immediate exposure to several holdings (within the fund), the investor has increased their portfolio diversification, lowering their overall risk.
How do you invest in an index fund?
You’ll need to open an account, like a retirement account or traditional brokerage account, at any brokerage firm. NextAdvisor recommends companies like Fidelity, Vanguard, and Charles Schwab, just to name a few. Take a look at NextAdvisor’s best online brokers, according to five financial experts.
Your investments should be long-term goals that you don’t plan to touch until you decide to retire, whenever that may be.
Who should invest in index funds?
Index funds aren’t restrictive. If you want to invest in them, you can — and should.
“Index funds cover a wide variety of sectors and asset classes, help to reduce risk, and bring instant diversification to a portfolio,” Hanson says. “Index funds are also easier and less time-consuming to research than individual stocks due to the nature of a fund’s holdings.”