Index funds track specific markets.
Stock market and bond index funds are part of a strategy for building wealth, but you might not know which ones you should choose. Index funds follow particular markets, such as small or large cap stocks, the S&P 500, the Russell 2000, bonds and international markets.
Instructions
1. Decide what type(s) of investments you want your index funds to track; that might be bonds, stocks, a domestic index fund or an international index fund. This is not an easy decision to make, since no one knows precisely the prospects for each asset class. Sometimes advisors suggest investing in a few index funds that cover several of these asset types, so that you have strong diversification in your investment portfolio.
2. Next, begin your search for index funds that match your investment goals. Two of the largest providers are Fidelity and Vanguard, but there are many other players as well. Usually, you can guess what an index fund invests in by its name, but look in the index fund's prospectus and read its objective to find out for sure. You should be able to find out the name of the index that the index fund tries to track, and then you can do further research to find out whether tracking that index is what you want. You can get prospectuses from the fund companies.
3. No matter which index or indices your like for your funds, find out the fees or fund expenses you will be charged. You will not get the best returns if too much is eaten away by excessive fees. Index funds are cheap to operate, so you should look for total fund expense ratios to be less than 0.5 percent. Some are even as low as 0.1 percent.
4. Along with fees, consider the trading costs that might be involved in buying or selling index funds. Some index funds require you to pay a trading fee while others do not. If possible, find index funds that you like that have low trading costs and management fees.
5. Finally, look into how closely the index fund actually tracks its target index. Since index funds employ different strategies, some index funds are better at tracking their index than others. There is a statistical metric, known as "R-squared," which measures how closely the index fund mirrors its target index. This may be found on financial websites or in the fund's prospectus. The closer the R-squared is to 100, the better the index fund is at doing its job. Usually, this is not an issue, but it is important to check, so that you know your index funds will perform as expected.
