How to Start Investing in Index Funds

The basic steps to buy an index fund

To invest in an index fund, you open a brokerage account, deposit money, search for the index fund you want, and place a buy order. The whole process takes about 15 minutes once your account is set up. Most brokerages let you open an account online in under an hour, and you can start investing the same day your money arrives.

The three things you need before you buy are a brokerage account (the place that holds your money and executes trades), cash to invest, and the name or ticker symbol of the index fund you want. A ticker symbol is a short code — for example, VOO is the Vanguard S&P 500 ETF, and VTSAX is the Vanguard Total Stock Market Index mutual fund. Once you have those three things, buying takes one or two minutes.

Key Takeaways

• You buy index funds through a brokerage account, which you can open online at firms like Vanguard, Fidelity, or Charles Schwab in about an hour.
• Index funds come as either mutual funds (which you buy once per day at the closing price) or ETFs (which trade throughout the day like stocks).
• Most brokerages charge no commission to buy index funds, but ETFs have a small bid-ask spread that costs a few cents per share.
• You can invest a lump sum all at once or set up automatic monthly deposits, and both approaches work for long-term investors.
• Index funds held in a regular taxable account are taxed on dividends and gains, but holding them in a 401(k) or IRA avoids or delays those taxes.

Choosing a brokerage to open your account

A brokerage is a company that holds your cash and lets you buy and sell investments. The major brokerages for individual investors are Vanguard, Fidelity, Charles Schwab, and E*TRADE. Each one has a website and a mobile app, and each one lets you open an account online without visiting an office. You do not need to be rich or have a minimum balance to start — most have no account minimums at all.

The main difference between brokerages is which index funds they offer and how much they charge. Vanguard owns many of the largest index funds and often charges less than competitors. Fidelity and Schwab also offer low-cost index funds and have good customer service. E*TRADE is similar but slightly more expensive. For most people starting out, any of these four will work. Pick one, open an account, and move on — the difference in cost between them is small compared to the difference between investing and not investing.

When you open an account, the brokerage will ask whether you want a taxable account or a retirement account (like a 401(k) or IRA). If you are saving for retirement and have not maxed out a 401(k) or IRA, start there — the tax benefits are worth more than the small fee differences between brokerages. If you are investing money you might need before retirement, use a taxable account.

Depositing money into your account

Once your account is open, you link a bank account and transfer money to your brokerage. This usually takes one to three business days. Most brokerages let you link your account online by entering your bank login information, or you can give them your bank's routing number and your account number to set up a wire transfer.

You can deposit as much or as little as you want. Many people start with a lump sum — say, $1,000 or $5,000 — and then set up automatic monthly transfers. Automatic transfers are useful because they force you to invest regularly without having to remember to do it. You can usually set this up in the brokerage's settings in two minutes.

Finding and buying the index fund

Once money is in your account, search for the index fund by name or ticker symbol. If you want a total U.S. stock market fund, you might search for "VTSAX" (Vanguard Total Stock Market Index mutual fund) or "VTI" (Vanguard Total Stock Market ETF). If you want an S&P 500 fund, search for "VFIAX" (Vanguard S&P 500 Index mutual fund) or "VOO" (Vanguard S&P 500 ETF). The brokerage will show you the fund's price, its expense ratio (the annual fee), and how much it has grown over the past year or five years.

Click the fund, enter how many shares you want to buy or how much money you want to spend, and click "buy" or "place order". If you are buying a mutual fund, the order goes through at the end of the trading day (usually 4 p.m. Eastern time). If you are buying an ETF, it goes through immediately at the current market price. Either way, the shares appear in your account within a few minutes, and you own them.

Most brokerages charge no commission to buy index funds. ETFs have a tiny cost called the bid-ask spread — the difference between what buyers are willing to pay and what sellers are asking — but this is usually just a few cents per share and is built into the price you see. Mutual funds have no bid-ask spread because they are priced once per day.

Mutual funds versus ETFs: which to buy

Both mutual funds and ETFs track the same indexes and have similar costs. The main difference is when and how you buy them. A mutual fund is priced once per day at the market close, so your order goes through at that day's price no matter what time you place it. An ETF trades throughout the day like a stock, so you see the price change minute by minute and your order goes through at whatever price the market is at when you click buy.

For a beginner investing a few hundred or a few thousand dollars, this difference does not matter much. If you plan to invest the same amount every month, a mutual fund is slightly simpler because you do not have to think about the price. If you like watching your investments and want to buy at a specific price, an ETF gives you that control. Both are good choices; pick whichever feels more natural to you.

One practical note: some brokerages offer their own index funds at lower cost than competitors' funds. Vanguard's VTSAX costs less than Fidelity's FSKAX, which costs less than Schwab's SWTSX, even though all three track the same index. If you open an account at Vanguard, buy Vanguard's funds. If you open at Fidelity, buy Fidelity's. You will save a small amount on fees.

Investing a lump sum versus investing monthly

You can put all your money in at once, or you can split it into monthly deposits. Research shows that investing a lump sum all at once tends to produce slightly better results over time, because your money spends more time in the market. But investing monthly is easier psychologically — it feels less risky to spread your money out — and the difference in long-term returns is small.

If you have money sitting in a savings account and you are confident you will not need it for at least five years, invest it all now. If you are nervous about market timing or you are investing money you might need sooner, invest monthly. The most important thing is to start and to keep going. Someone who invests $500 per month for 20 years will end up with far more than someone who waits for the "perfect time" to invest a lump sum.

Tax considerations for index fund investing

Index funds held in a regular taxable brokerage account are taxed on two things: dividends (the small payments companies make to shareholders) and capital gains (the profit you make when you sell). The tax bill comes due every year, even if you do not sell any shares. Index funds are tax-efficient compared to actively managed funds because they trade less often, but you still owe taxes.

If you are investing for retirement, use a 401(k) or IRA instead. In a 401(k), you contribute pre-tax money (lowering your taxable income that year) and pay taxes only when you withdraw in retirement. In a traditional IRA, the same applies. In a Roth IRA, you contribute after-tax money but pay no taxes on the growth or withdrawals in retirement. All three let you invest in index funds without worrying about annual tax bills. If your employer offers a 401(k) match, contribute enough to get the full match before investing in a taxable account — that match is assistance programs.

Once you have maxed out retirement accounts, a taxable account is the next place to invest. The taxes are real but manageable, especially if you hold the funds for many years and let them grow.

Frequently Asked Questions

How much money do I need to start investing in index funds?

Most brokerages have no minimum, so you can start with $100 or $1,000. Some index funds have minimums of $1,000 or $3,000 for mutual funds, but ETFs have no minimum — you can buy a single share. Start with whatever you have and add more as you can.

Can I buy index funds through my employer's 401(k)?

Yes. Most 401(k) plans offer several index fund options. Check your plan's investment menu or ask your HR department. Investing in a 401(k) is usually better than a taxable account because of the tax benefits, so start there if you can.

What happens after I buy an index fund?

You own it. The fund automatically reinvests dividends (or you can choose to receive them as cash), and the fund's value changes daily as the stocks inside it go up and down. You do not have to do anything. Most people check their balance once a month or once a quarter and keep investing regularly.

Should I sell my index fund if the market drops?

No. Market drops are normal and temporary. Selling locks in your loss and means you miss the recovery. Index fund investors who hold through downturns and keep investing end up with more money than those who sell and wait for prices to rise again.

Can I set up automatic investing after I buy my first index fund?

Yes. Most brokerages let you set up automatic monthly or weekly transfers from your bank account. You can usually do this in your account settings in a few minutes. Automatic investing is one of the best ways to stay consistent.