Investing's Hot Fudge Sundae

So many stocks to buy, but where do we turn first? It's a question not only for new investors, but for more seasoned ones, too. The more savvy among us might not even look at individual securities when they begin. They'll turn instead to mutual funds. And not just any mutual fund, but index funds.

There are a number of reasons you might want to invest in an index fund as your first investment, and then keep adding to it as your investing experience -- and portfolio -- grows.

One scoop or two?
Index funds -- the plain vanilla choice for investors -- offer instant diversification over a range of stocks, industries, and market caps. For example, an index fund that mimics the S&P 500 covers the 500 largest stocks in the market today. By broadly diversifying your investment across many stocks, you reduce the volatility of your portfolio, since no individual stock can wreak havoc should it turn in a bad performance. Although some believe that limits your upside potential, the stock market -- as measured by both the S&P 500 and the Dow Jones Industrial Average (DJIA or just "the Dow") have averaged annual growth rates of 10.5%, which is none too shabby.

In addition to stock diversification, it gives you sector diversification too. The Dow index -- which covers 30 largely "industrial" stocks -- includes technology stocks Microsoft and Intel, health-care stock Johnson & Johnson, financial company JP Morgan Chase, retail king Wal-Mart, and more. Again, with sector diversity, you're protected against one industry exerting too much of an impact on your portfolio.

With an index like the Wilshire 5000 (which actually has more than 7,000 stocks), you're getting almost total market coverage. But to get smaller pieces of the stock universe, you have to look to other indexes. Below is a chart of some of the most popular, well-known indexes which people turn to almost daily to track their investments, measure how "the market" is doing, or see how their stock picks stack up:

While these are five of the most popular indexes, there are plenty of others. As index investing has exploded in popularity, brokerages and investment companies have tried to expand the list of choices available to investors.

Today you can get not only broad-market indexes like those above, but also more narrowly focused ones. There are indexes that zero in on specific sectors like health care, utilities, or financial services. You can invest in indexes that measure overseas markets, even specific countries, or in mutual funds indexes that trade like stocks, called exchange-traded funds (ETFs). If you've thought of index investing as boring and uninteresting, think again! Check out The Motley Fool's mutual fund center to see there are plenty of ways to spice up the white rice of investing.

Plain vanilla tastes best
Yet when it comes to your portfolio, plain vanilla just might be the way to go. Index investing was created by John Bogle, the founder of the Vanguard family of mutual funds, some 30-plus years ago, as a way for investors to benefit from low-cost, long-term, broadly diversified investments. While investors can move in and out of mutual funds relatively quickly, their more modern derivations have taken that to an extreme. ETFs, for example, have stood the benefit of buy-and-hold index investing on its head, allowing you to jump in and out as often as you want.

Keep in mind that that such a volatile investing strategy raises your costs, lowers your returns, and subjects you to the vagaries of market volatility that you were trying to avoid in the first place.

Several excellent mutual fund managers can actively manage a portfolio that consistently beats the indexes. Motley Fool Champion Funds selects some of the best managers every month, and recommends them to subscribers: fund families like T. Rowe Price, Third Avenue, and Royce. Yes, there are even indexes from Vanguard included.

Sprinkle your portfolio with the best
Index funds are an excellent way to get involved in investing as well as to provide the ballast that will keep your portfolio afloat well after you've become a market maven.

For help in finding those that meet your needs best, there's a 30-day free trial subscription available to Champion Funds that gives you complete access to the services index-beating recommendations. Go ahead. Put a dollop of hot fudge sauce onto your plain vanilla investments. It'll be the cherry crowning your portfolio's sundae.