How To Choose The Right Index Fund?

Answer 1

When people want to choose an index fund for investment, it may look like most choices out there are essentially the same. Dozens of companies may offer an S&P 500 index fund and on the surface they may all seem essentially identical so you may feel tempted to choose any one of them because they all seem the same. But in many cases, they’re not.

Not all index funds are created the same. While all S&P 500 index funds are probably substantially similar there are a few things you want to check for first before making a final decision. It’s these things that will help you choose the best fund out of the bunch.

First of all, examine the management fee structure of the fund. Many index funds, like Vanguard’s, charge only a bare bones expense ratio. Lower fees mean more money in your pocket and a closer overall replication to the underlying index. You may be surprised to learn that some index funds charge a full 1.5% or more to passively manage your money. These funds should be avoided because you’ll almost always end up behind most other index funds.

Second, check out the fund’s transaction fee structure – particularly if there is a fee to buy or sell or if there is an early redemption fee. Some funds have such a significant asset base that they won’t charge these fees but smaller funds may in order to discourage market times and rapid traders. Make sure you don’t unknowingly get dinged a fee.

Third, take a look at what the fund is invested in. It may sound silly but the prospectus of some funds will allow them to deviate to a surprising degree from the underlying index. If you find that an S&P 500 index fund is 20% invested in small company stocks, you’re not actually getting what you think you are and it may result in unexpected losses for you.