4 Steps to Invest in an Index Fund — the Right Way
If you’re looking for a way to invest in a US market index such as the S&P 500 or Dow Jones Index, then you’re on your way to successful investing.
Investing in a market index is the foundation of passive investing (the opposite of day trading!). Instead of paying an expensive financial advisor or fund manager to pick stocks that beat the market, you want a diverse strategy with the lowest fees. You might be surprised to know that investment managers use this strategy themselves.
Charles Schwab, the legendary investor, was asked why people try to beat the market with active investing, when they usually end up under-performing it.
“It’s fun to play around…it’s human nature to try to select the right horse…(But) for the average person, I’m more of an indexer…The predictability is so high…For 10, 15, 20 years you’ll be in the 85th percentile of performance. Why would you screw it up?
So what are the S&P 500 Index and Dow Jones Industrial Average (DJIA)?
First of all, the S&P 500 and DJIA are not investments. You don’t buy and sell them. Think of them as accepted measuring tools of the US Equity Market, and they are maintained by a private company called S&P Global.
The S&P 500 tracks (you guessed it) 500 large US companies that make up ~80% of the US economy. This is the gold standard for following the US economic performance. The S&P is market-cap-weighted, which just means that the larger companies have a bigger effect on how the S&P 500 fluctuates over time. S&P Global has its own methodology for choosing these companies, and as of last month, the top 10 were as follows:
The Dow Jones Industrial Average (DJIA) is an index that follows 30 large US companies. It is notable as one of the world’s first indexes, introduced in 1896. It is not a great indicator of the US economy, since it is price-weighted. It’s fame is mainly from its long history.
Step #1 — Open a Brokerage Account
Before you can buy any investments, you’re first going to need a brokerage account. If you already have one, feel free to jump to the next step!
A brokerage account is a type of financial account that lets you store cash, and then use that cash to buy stocks, bonds, etc. After you open your account, you need to move cash into the account. Any wealth stored in this account will make up your “investment portfolio.” After you’ve deposited cash into the account, your investment portfolio is 100% cash.
Note: Commandiv is a great place to open this account. Not only can you buy and sell stocks for $0 in commissions, but we also give you personalized investment recommendations.
Step #2 — Choose an Exchange Traded Fund (ETF) that Tracks the Desired Index
Let’s assume that we want to invest in the S&P 500 Index, the gold standard for tracking the US equity market. We next have to find an “investment vehicle” that is well-structured and designed to track the S&P 500 as closely as possible.
An Exchange Traded Fund (ETF) is a great investment vehicle for this task. An ETF is like a basket of investments, maintained by an investment management company. An ETF has a ticker, so it’s easy to see how it’s performing in real time. They’re also easy to move from one brokerage to another, and can sometimes help you achieve lower fees than their counterpart: the indexed mutual fund.
Finding and choosing the best ETF to track the S&P 500 can be challenging. At Commandiv, we choose best-in-class ETFs for our clients by optimizing for lowest fees, sufficient liquidity and tax efficiency.
Here are a few ETFs that track the S&P 500:
Step #3 — Decide Your Target Allocation
Next we need to decide how much to buy. One way to think about your investment portfolio is on an allocation basis. The total value of your account is 100%, and the value of each investment is a percentage of your total.
For example, if you just opened up a brokerage account and deposited $10,000, then cash would be 100% of your investment portfolio. If you used $5,000 to buy shares in Ford Motor Company (F), then your allocations would be 50% in Ford, and 50% cash.
It’s up to you to decide the target allocation of your investment portfolio. We try to simplify this at Commandiv by providing a recommended target portfolio personalized to you. We also choose the best ETFs for each allocation and calculate the number of shares you should trade in each.
Once you have a target allocation percentage, it’s time to calculate your trade and send the trade to the market through your brokerage account.
Step #4 — Create and Execute the Trade Order
A little bit of math and then we’re done! In the last step, you chose your Target Allocation. Let’s figure out your Target Investment Size:
Target Investment Size = Target Allocation (%) x Total Portfolio Value
Now that we have your target investment size, we can easily determine how many shares to buy.
Shares to Buy = Target Investment Size / ETF Share Price
Now that you have chosen the ticker and calculated the number of shares to buy, it’s time to send the order to the market. Once the order is filled in the market, you’re done! 🎉🎉🎉
Automate This Process with Commandiv
We built Commandiv as a smarter stock-trading platform with investment recommendations to make this process easier and quicker. Whether you want recommended target allocations, or you want to meticulously set them yourself, we’ll always recommend the best ETFs and suggest exactly how many shares you should buy and sell to achieve the portfolio you want.
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If you’re interested in simplifying your investments, visit our website at www.commandiv.com. Also feel free to email us at founders at commandiv dot com.
edited by Tom Goldenberg
