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Question: I've read that are the smartest choice for someone like me who's interested in long-term, low-fee, passive . But there are so many to choose from! How do I go about picking a that be worth holding onto for years? -- Helen, New Orleans
TheAnswer: Great question, Helen. I personally love investing in . They're an excellent choice for 401(k)s and other retirement plans as well as normal accounts -- especially if you don't want to have to spend hours researching your performance every quarter.
An index fund is simply a mutual fund that tracks a market index and mirrors the performance of that . So if I invest in the Vanguard 500 (VFINX), which tracks the S&P 500 , and the S&P 500 goes up 5%, the Vanguard go up almost 5% as well.
Because track indexes, they don't have portfolio managers actively buying and selling within the as regular mutual do. And with less activity from the , often carry much lower expense fees and are potentially less risky than normal mutual with managers who try timing the .
That also means that you, the investor, don't need to carefully compare the performance of the to the 's performance because with an , you're essentially investing in the you're comparing against.
In short,are a low-cost, hassle-free way to diversify into several different types at once -- and for the long-haul.
Several brokers, including Vanguard, Charles Schwab, Fidelity and others, , all of which are very similar except for one thing -- expense fees. You'll want to look for with the lowest expense ratios, which you can find on every mutual 's prospectus page or on Morningstar.com. That can help you keep your costs down and your returns growing as much as possible. Typically, an with an annual expense ratio that's 0.6% or less is decent, but an expense ratio under 0.25% is ideal.
So, how do you choose the "right" ?
Before we dive into the various types of ) or talk to a trusted , let's talk big picture -- your mix. Remember, everyone's portfolio is different. Yours should be made up of different types that fit your age and risk tolerance, so do your research on portfolio allocation (here's an article for some for more help on that.
For our purposes, I'll keep this basic.
As I talked about in my article, The Lazy Man's Retirement Portfolio, there are basically four major asset classes in which to invest: U.S. , foreign , and . You can also invest in , but they're a bit outside of the normal asset classes so we'll skip that one for today.
For each of the asset classes you want to invest in, you'll want an that tracks it.
If you want exposure to American companies, you may want an , which includes virtually every small-, medium- and large-cap that tracks the Wilshire 5000 traded in the United States -- more than 5,000 companies in all. An example of an that does this is the Vanguard Total (VTSMX).
If you're looking to invest only in large, established companies (Wal-Mart, Exxon, Apple, etc.), you may prefer to go with an that tracks the S&P 500 (like the one I mentioned earlier, for example), which tracks the 500 largest companies in the United States.
For exposure to companies in countries with explosive economic growth, foreignare just the ticket. There are plenty of emerging countries to choose from that invest in companies in Mexico, China, Brazil and others, as well as developed countries , which invest in companies in Europe, Japan, Canada and others.
If you want exposure to both emerging and developed countries, choose an , which follows companies in Europe, Australia and the Far East. An example of an that tracks the MSCI that does this is the Vanguard Total International Investor (VGTSX).
If you want to own a part of apartment complexes, retirement homes and other kinds of properties, VGSIX). trusts (REITS) are the easiest way to do it without having to buy land. To get this kind of exposure, you'll want an that follows the MSCI US REIT , which represents 85% of the REITs in America. An example of a REIT that does this is the Vanguard REIT (
So, three steps in all: Determine the type of asset class in which you'd like to invest, find a brokerage firm that offers low-cost index funds that track those asset classes (the ones mentioned earlier are a good place to start), then just set and forget. Index fund investing is as simple as that.
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