When Buying an Index Fund Is Stupid

For many investors, it's hard to beat a broad-market index fund. Simply via a one-time investment, you'll immediately be part-owner of 500 big American companies, such as American Express (NYSE: AXP  ) , Intel (Nasdaq: INTC  ) , and Alcoa (NYSE: AA  ) . You won't have to study any companies, or make myriad buy-sell decisions. Over the long haul, the S&P 500 has averaged a 10% annual gain, and depending on how your particular investing time frame pans out, you stand a chance of beating (or underperforming) that.

It's true that we at The Motley Fool think you can beat the market (and thus broad-based index funds, as well) via some carefully chosen managed mutual funds. But in addition to such funds, or simply instead of them, index funds offer compelling performance for minimal effort.

Be careful
Even though deciding to go with index funds can be very smart, you still have to pick the right one. As it turns out, not all index funds, even those that go beyond the large-cap S&P 500 to invest in the entire U.S. stock market, are the same. Sure, all standard ones will hold the same basket of thousands of stocks, in pretty much the same proportions. Each will list ExxonMobil (NYSE: XOM  ) as its top holding (representing around 3.3% of its overall portfolio's value), followed by General Electric (NYSE: GE  ) (1.9%) and Microsoft (Nasdaq: MSFT  ) (1.6%). But the fees can vary widely. Check out these examples:

Fund

Expense ratio

Fidelity Spartan U.S. Equity Index 

0.09%

Vanguard Total Stock Market Index (FUND: VTSMX  )

0.15%

T. Rowe Price Total Equity Market Index 

0.40%

Schwab Total Stock Market Index 

0.52%

Source: Morningstar.

The various funds also differ in their minimum investment amounts, and those with higher minimums tend to have lower fees. Schwab offers one such fund with an expense ratio of 0.52% and a minimum of $100, and another fund with an expense ratio of 0.37%, along with a minimum of $50,000. Fidelity Spartan's expense ratio is a mere 0.09%, but its minimum is $100,000. Look beyond the single expense-ratio number, too, as some funds charge sales loads and account maintenance fees, escalating the costs further.

So choose carefully, and don't pay more than you need to. Even small cost reductions can put thousands more in your pocket.

Learn more about index funds. If you're curious about which actively managed funds the Fool thinks will beat the indexes, take advantage of a free 30-day trial of our Champion Funds newsletter.

Longtime Fool contributor Selena Maranjian owns shares of Microsoft. Microsoft, Intel, and American Express are Motley Fool Inside Value picks. The Fool owns shares of American Express. The Motley Fool is Fools writing for Fools.


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