Investing in index funds for dummies

index investing for dummies
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Index investing has gained momentum lately.  And rightly so for the low cost and and no nonsense approach it provides to the serious investor.

Index investing is the simple path to wealth.  

What are Index Funds

Let us understand Index with an example.  If you are into sports and let’s say you are given an option – either buy one player or buy the entire team of your choice.

If you bought an entire team – you are not dependent on one player’s performance.  Instead, if all the majority of the players performed well, your team wins.

Same goes for index funds.  Instead of buying a handful of stock and risking your money solely on these stocks, you buy the complete lot – all of them ! how about that, eh?

And nobody gets to pick and choose, you buy the entire basket of whatever Index you are interested in. 

Categories of Index funds 

Index funds can be classified broadly as either Equity Index fund or Fixed Income index fund.

Index Funds vs Index ETF

Almost similar due to the fact that your money ends up buying the same set of stocks in the Index.  

ETF offer slightly lower cost and are tradable like a stock is. Index fund on the other had is a mutual fund (passive) that gets its NAV calculated at EOD and you get units/shares assigned.

Pros and Cons

Passive: Index funds are passive investment.  This is good. Nobody (portfolio manager) gets to tinker with investment decisions.  

Low expense: Because this is passive investment, the costs are low. 

Diversification: Index funds by definition buy the whole bunch of stocks that form a part of the Index. for a fraction of the cost.  So, you get to hold all the big companies for a small cost.

DIY: Index investing is ideally suited for DIY investor.  someone who wants a no nonsense approach to investing would be attracted to this form of investing.  It is not necessary to have multiple instruments for multiple financial goals – vacation, education, retirement, etc.

Cons:  Not much, except that this is  a “boring” kind of investment. Not much advertisements, not much buzz.  

No big gains: No big gains, no big losses.  Apparently, you may miss out on the hot stock that ran up.  But, if you are not into chasing the hot stocks, it won’t matter.

Why should you invest in index fund?

low cost is the first advantage.  

diversification.  you get to own all types of stocks and take part is their growth.simple and easy to follow.  no complications. yet better returns.

Where to invest in index fund?

one of the top names is Vanguard

How many types of index funds?

Pure Equity: these index funds are invested in the stocks that are part of the index.

Pure Bond: these invest only in the bond index, providing stability.

Having both in your portfolio would help curb wild swings as a result of volatility in the market

Retirement savings

for retirement savings, index funds and etfs are the best instruments.  They have historically beaten inflation and given better returns.  And add to that the fact that they are low cost vehicles.  how much do you need for retirement?  check out the FIRE (Financial Independence Retire Early) calculator here.

How much to invest in Index fund?

as much as is needed for all your financial goals. also, it would be best if you have a mix of Bond Index fund/etf and Equity Index fund/etf.  this way, you save in a balanced manner.  You could follow the rule of 110 to arrive at ratio between the two.

Should you invest now?

no, you should have invested yesterday.  If you missed investing yesterday, go ahead and invest now.  

do not try to time the market.  ignore the buzz and news going around.  it is not timing the market, but time in the market that made money.

the question of “should i be investing in the market now?” has been answered here.

In conclusion

no matter at what stage of life you are in, index funds/etfs should be your core portfolio.  Just because the logic presented here is way too easy and boring does not mean it should be written off for the lure of fancy advertisements or some algorithmic trading with tall claims. 

eventually simplicity wins

of course, once you’ve accumulated a sizeable portfolio of index funds – you could use them to generate income using instruments known as Options.  check out the article here.

below are a list of highly recommended books on amazon to get you started:

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