How to Start Investing in an Index Fund

The basic steps to buy an index fund

To invest in an index fund, you open an account at a brokerage firm, deposit money, search for the fund by its ticker symbol, and place a buy order. The whole process takes about 15 minutes once your account is set up. Most brokerages let you start with as little as $1, though some index funds themselves have minimum investments of $500 to $3,000.

The account setup is the longest part. You will need to provide your name, address, Social Security number, and employment information. The brokerage runs a background check, which usually clears within one business day. After that, you can fund the account by linking a bank account or transferring money, and you are ready to buy.

Once you own shares, you do not have to do anything. The fund automatically holds all the stocks in its index, rebalances when needed, and sends you any dividends. You can check your balance anytime online, and you can sell whenever you want — though most index fund investors hold for years.

Key Takeaways

• You need a brokerage account to buy an index fund; opening one takes 10 to 15 minutes and requires your name, address, and Social Security number.
• After your account is approved and funded, you search for the fund by its ticker symbol and place a buy order just like you would for a single stock.
• Most brokerages charge no commission to buy index funds, though some funds charge a small annual fee (usually under 0.20% per year for passive index funds).
• You can start with as little as $1 at many brokerages, though individual index funds may require a minimum investment of $500 to $3,000.
• Once you own the fund, it requires no active management — the fund holds all its stocks automatically and you can hold it for decades.

Choosing a brokerage

A brokerage is a company that lets you buy and sell investments. The major ones for individual investors are Fidelity, Vanguard, Charles Schwab, E*TRADE, and Robinhood. Each one offers index funds from many different fund companies, so you are not locked into one fund family by choosing a brokerage.

The main differences between brokerages are the user interface (how easy the website or app is to use), customer service quality, and whether they offer extras like financial planning tools. Most charge no commission to buy index funds. Some offer fractional shares, which means you can invest $50 and own a partial share of a fund instead of waiting until you have enough for a full share.

If you already have a bank account, you might start there — many banks now offer brokerage services alongside checking and savings. If you do not, Fidelity and Vanguard are popular choices for long-term index fund investors because they offer low-cost funds and solid educational resources.

Finding and buying the specific fund

Once your account is open and funded, you search for the index fund you want by its ticker symbol — a short code like SPY, VOO, or VTI. Every fund has one. You can find the ticker on the fund company's website or by searching the fund name on your brokerage's site.

When you search, the brokerage shows you the fund's current price, its annual fee (called the expense ratio, usually shown as a percentage), and basic information like how many stocks it holds. Read the expense ratio carefully — it is the only ongoing cost you will pay, and it comes out automatically each year. For a broad market index fund, anything under 0.20% per year is considered low-cost.

To buy, you enter the number of shares you want or the dollar amount you want to invest, review the order, and click confirm. The order goes through immediately during market hours (9:30 a.m. to 4 p.m. Eastern time on weekdays). If you buy after hours or on a weekend, the order executes at the next market open.

Understanding the costs you will pay

The main cost is the expense ratio — the annual fee the fund charges to cover its operating costs. For an index fund tracking the S&P 500, this is typically 0.03% to 0.10% per year. That means on a $10,000 investment, you pay $3 to $10 per year. The fee is deducted automatically from the fund's value, so you never write a check.

Some brokerages charge trading commissions, but most major ones have eliminated these for index funds. A few brokerages charge account maintenance fees if your balance falls below a certain amount, usually $500 to $2,500. Check your brokerage's fee schedule before opening an account.

When you sell the fund, you may owe capital gains tax if the fund's value has risen since you bought it. This is not a cost of the fund itself, but a tax you owe to the government. If you hold the fund in a tax-advantaged account like a 401(k) or IRA, you do not pay tax until you withdraw the money in retirement.

Tax-advantaged accounts for index funds

If your employer offers a 401(k), you can often invest in index funds through it. Money you contribute comes out of your paycheck before taxes, which lowers your taxable income. Some employers match a portion of what you contribute — this is assistance programs and worth taking advantage of.

If you do not have access to a 401(k), you can open an IRA (Individual Retirement Account). A traditional IRA lets you deduct contributions from your taxes now, and you pay tax when you withdraw in retirement. A Roth IRA uses after-tax money now, but withdrawals in retirement are tax-free. For 2024, you can contribute up to $7,000 per year to an IRA (or $8,000 if you are 50 or older).

Both 401(k)s and IRAs let your index funds grow without paying tax on dividends or gains each year. This is a major advantage over holding index funds in a regular brokerage account, where you owe tax on gains every year. If you are just starting out, maxing out an IRA is often the best first step.

What happens after you buy

After you place your order, the fund appears in your account within one business day. You can see your current balance, the number of shares you own, and the current value anytime you log in. Most brokerages show you a chart of how your investment has performed over time.

If the fund pays dividends (most do), the brokerage automatically reinvests them by buying more shares of the fund. You can change this setting if you want the dividends paid in cash instead, but reinvesting is usually the better choice for long-term investors because it compounds your returns.

You do not need to do anything else. You do not need to rebalance, monitor individual stocks, or make trades. If you want to add more money, you can deposit it and buy more shares anytime. If you want to sell, you place a sell order the same way you placed a buy order.

Common mistakes to avoid

The biggest mistake is trying to time the market — waiting for the price to drop before buying, or selling when it rises. Index fund investors who buy regularly and hold for years almost always outperform those who try to time their trades. If you are nervous about a market drop, remember that you are buying the whole market, and the market has recovered from every downturn in history.

Another mistake is paying too much in fees. Some index funds have expense ratios above 0.50% per year, which is expensive for an index fund. Compare the expense ratio of the fund you are considering to others tracking the same index — you will usually find a cheaper option.

A third mistake is holding index funds in a regular brokerage account when you could use a tax-advantaged account. If you are under 59½ and withdraw from a traditional IRA early, you pay a 10% penalty plus income tax, but this only matters if you actually withdraw. For most people, the tax savings of using an IRA far outweigh the risk of needing the money.

Frequently Asked Questions

How much money do I need to start?

Most brokerages let you open an account with $0 and buy fractional shares with as little as $1. However, some index funds themselves require a minimum investment of $500 to $3,000 for the first purchase. Check the fund's prospectus or your brokerage's website to see if the specific fund you want has a minimum.

Can I lose money in an index fund?

Yes. If the market drops, the value of your index fund drops too. However, index funds spread your money across hundreds or thousands of stocks, so you are not betting on any single company. Historically, the stock market has risen over every 20-year period, though past performance does not may provide future results.

Should I buy all at once or invest gradually?

Research shows that lump-sum investing (putting all your money in at once) slightly outperforms dollar-cost averaging (investing the same amount regularly over time) on average. However, dollar-cost averaging can feel less risky psychologically and works better if you are nervous about market timing. Either approach beats not investing at all.

What is the difference between buying an index fund and buying an ETF that tracks the same index?

Index funds and ETFs that track the same index have nearly identical holdings and expense ratios. The main difference is that ETFs trade like stocks (you can buy and sell during market hours at changing prices), while mutual funds trade once per day at a fixed price. For most long-term investors, this difference does not matter.

Do I have to report index funds on my taxes?

If you hold index funds in a regular brokerage account, your brokerage sends you a tax form (1099-DIV or 1099-B) showing dividends and gains. You report these on your tax return. If you hold them in a 401(k) or traditional IRA, you do not report anything until you withdraw. With a Roth IRA, may have access to withdrawals are not reported at all.