How to Invest in Index Funds in 2024: Get Broad Market Exposure

Billions of dollars are invested in index funds every year – and it’s easy to see why, as these products are a great way to build long-term wealth.

But what constitutes an index fund? Are they suitable for everyone, and should you consider one instead of an actively managed portfolio?

Our guide on how to invest in index funds for beginners and professional investors will cover everything from defining what is an index fund to whether you should embrace them.

Key Takeaways

  • Index funds track a particular index – and there are many to choose from. For example, it could be a global stock market, such as the S&P 500, or one focused on a sector, such as healthcare.
  • Index funds aim to mirror the performance of a particular index – and not try to outperform it, which is the goal of active fund managers.
  • The first publicly available index fund was launched back in the mid-1970s thanks to the efforts of the late John C. Bogle, Vanguard’s pioneering founder.
  • Index funds often perform better than actively managed funds over longer investment horizons.
  • There are still risks involved with this style of investing. If the tracked index falls, then your investment’s value will follow.
  • You can diversify your portfolio by holding several different index funds covering a variety of stock markets or sectors.

What Is an Index Fund?

Index funds are investment vehicles that track a particular index. This could be a global stock market, such as the FTSE 100 or S&P 500, or an index focused on a particular sector, such as healthcare or financials.

The objective of these funds is to simply mirror the performance of whatever index they’re following rather than trying to outperform it.

This means they don’t require managers to decide which individual investments they should buy or sell, which is what happens in active mutual funds.

There are benefits to this so-called passive approach to investing – and the main one is cost, according to Morningstar, the US financial services firm.

“They are generally cheaper as their fees are lower,” it pointed out. “This is because the process of tracking an index can be highly automated, and costs can be minimized through scale.”

At this point, it’s also worth mentioning exchange-traded funds (ETFs). These are baskets of securities, such as stocks and bonds, that are bought and sold on stock markets.

They have become a popular way to track specific markets or indices, such as the FTSE 100 or S&P 500, in a relatively straightforward, cost-effective way.

While ETFs and index funds are similar, there are differences. The main one is that an ETF can be bought or sold at any time during the day, whereas with index funds it’s only once.

Why Invest in Index Funds?

Index funds can provide a very straightforward, cost-effective, and diversified way for people to steadily increase their wealth over time.

Investors in these products expect their chosen index to rise over the long term, even if it encounters some turbulence along the way.

A prime example is the performance of the FTSE All-World Index, which has delivered an average annual return of 9.3% in sterling terms since 1993, according to Vanguard.

FTSE All-World Index

However, the performance of the index in individual years has been rather less stable. It has risen more than 20% in some years and fallen by a similar amount in others.

That doesn’t mean to say you won’t lose money in an index fund. The reality is that if the stock market – or index being followed – falls, then so will the value of your investment.

How Do Index Funds Work?

They will ideally track a specific index by buying shares in every company that’s listed on it, therefore guaranteeing accurate replication.

For example, if its goal was to follow the blue-chip FTSE 100 index in London, then it would be snapping up shares in the 100 stocks populating that index.

However, it isn’t always practical – or possible to own every single stock. In those instances, an index fund might buy a representative sample instead.

How different funds work will vary, as will their ability to accurately track indices. The difference between a fund’s returns and the target index is known as the tracking error.

Therefore, it makes sense to gauge the size of this tracking error when deciding between rival funds if, for example, you’re looking at how to invest in S&P 500 index funds.

Index Funds vs. Actively Managed Funds

So, what are the comparisons between active mutual funds vs. index funds?

It’s one of the longest-running debates: Should investors opt for actively managed portfolios, or does it make more sense to take a passive approach with low-cost index funds?

Index funds replicate the performance of an index, whereas the managers of active funds will pick and choose securities they believe will help them outperform that index.

If an active manager makes the right calls, then they can substantially outperform their benchmark index and deliver handsome returns to investors.

For example, the S&P 500 enjoyed a strong end to 2023, with a buoyant economy helping it to achieve a 24% gain over the year. However, some of the best-performing active funds investing in large capitalization US stocks achieved returns of more than double that figure. The Baron Fifth Avenue Growth fund, for example, was up 57.9%, according to Morningstar.

Active fund managers earn their money during volatile market periods, where the quality of their research, analysis, and stock picking can prove beneficial.

It means they can avoid sectors or companies that are performing badly, which is not the case with index funds that have to embrace all the constituents.

Unfortunately, outperforming is extremely difficult. The performance of individual companies can be notoriously challenging to predict, and getting it wrong can hit your portfolio’s value.

It’s why actively managed funds have often failed to beat their benchmarks, especially over longer time horizons, according to an analysis by Morningstar. “Only one out of every four active funds topped the average of their passive rivals over the 10 years ended June 2022,” it noted.

The problems of active management have even been acknowledged by legendary investor Warren Buffett in letters to shareholders of his Berkshire Hathaway investment business.

“Over the years, I have made many mistakes,” he wrote. “Consequently, our extensive collection of businesses currently consists of a few enterprises that have truly extraordinary economics, many that enjoy very good economic characteristics, and a large group that are marginal.”

More than 90% of active funds underperformed the S&P 500 over the 15 years to June 30, 2023, according to SPIVA, which measures actively managed funds against their global benchmarks.
Get the latest SPIVA Scorecard results for markets around the world.
Source: S&P Global

It’s been a similar story in Europe over the past decade, with research showing that almost 93% of equity funds have outperformed the S&P Europe 350.

Get the latest SPIVA Scorecard results for markets around the world.
Source: S&P Global

Best Index Funds to Invest in

So, what have been the best index funds to invest in? Well, DFA US Large Company and Fidelity 500 Index are among those highly rated by Morningstar.

The following index funds earned the top Morningstar Medalist Rating of Gold for 2024:

# Name Expense Ratio TTM Yield
1 DFA US Large Company DFUSX 0,080% 1,29%
2 Fidelity 500 Index FXAIX 0,015% 1,43%
3 Fidelity Mid Cap Index FSMDX 0,025% 1,41%
4 Fidelity Total Market Index FSKAX 0,015% 1,40%
5 Fidelity ZERO Large Cap Index FNILX 1,32%
6 iShares Core S&P 500 ETF IVV 0.030% 1.42%
7 iShares Core S&P Total U.S. Stock Market ETF ITOT 0.030% 1.46%
8 iShares S&P 500 Index WFSPX 0.030% 1,42%
9 Mutual of America Mid-Cap Equity Index MAMEX 0,160% 1,33%
10 Schwab US Mid-Cap Index SWMCX 0,040% 1,51%

Pros and Cons of Investing in Index Funds

The positives of index funds are that they’re low cost, require little financial knowledge, and are convenient to invest in.

The negatives, meanwhile, include being stuck with poorly performing assets and the potential for returns to be beaten by successful active managers.

The reality is that anyone considering how to buy index funds should be aware there are risks with both approaches, according to an analysis by Columbia Threadneedle Investments.

“The possibility of growth and loss in an active fund may be more acute, but active managers can invest in a wider variety of assets, each with a different risk profile,” it stated.

This gives them the potential to diversify the overall risk in a portfolio and still maintain the opportunity for growth.

“When the market falls, a passive fund can only fall in value in the same way, mirroring that index, whereas an actively managed fund always has the potential to perform better than the market,” it added.

How to Invest in Index Funds and Get Broad Market Exposure

How to Invest in Index Funds 

So, what do you need to know about investing in index funds?

Step One: Know What You Want to Achieve

Be clear about your investment objectives. For example, do you want to generate a steady return over the next decade? Are you after a core holding for your overall portfolio? Is the aim to diversify with several index funds?

If one of these is your goal, then passive investing could be for you. However, if you want sky-high returns, then active management may be more suitable.

Step Two: Choose an Index to Follow

For those looking at how to invest in low-cost index funds, the first task is to pick what stock market or sector you want to track.

For example, you can opt for an S&P 500 index fund if you want to follow some of the largest US companies, such as Apple, Amazon, and Microsoft.

Alternatively, you may prefer to follow other prominent global indices, such as the FTSE 100 in London, and get exposure to the fortunes of AstraZeneca, Rio Tinto, and British American Tobacco.

Step Three: Compare Funds

You will then need to choose a fund that follows your chosen index. Take your time with this. Look at how long a fund has been operating and whether it has a good track record.

You also need to consider minimum investment levels and the expense ratio, which indicates how much it costs to run the portfolio.

If you’re wondering how to invest in fidelity index funds or how to invest in Vanguard index funds, then it’s worth visiting their websites.

Both investment houses provide extensive information on how they go about building and running their range of index funds.

Step Four: Buy Your Fund

You can often buy from the providers themselves, although many people prefer to open a brokerage account with one of the best broker platforms that enables them to trade index funds.

This could be a particularly good option if you’re planning to invest in several different index funds, as you’ll be combining your investments in one place.

Step Five: Monitor Your Decisions

You need to keep an eye on the performance of your fund to ensure it’s tracking the index efficiently. The tracking error will indicate how close it is to the return generated by the actual index.

History of Index Funds

Index funds have been around for almost half a century. The first publicly available index fund, First Index Investment Trust, was launched by Vanguard back in 1976.

This product – now known as Vanguard 500 – was the brainchild of the late John C. Bogle, Vanguard’s pioneering founder and the earliest advocate of index investing.

Mr Bogle, whose tireless work helped bring down costs across the entire mutual fund industry, famously declared: “Don’t look for the needle in the haystack. Just buy the haystack!”

While his idea was initially slow to catch on, index investing – also known as passive investing – has since become hugely popular.

Today there are thousands of index funds to invest in, covering every conceivable stock market and sector – and this expansion isn’t expected to slow anytime soon.

Growth of Index Funds

Passive funds have been growing in popularity for years and recently achieved the milestone of having more assets than their active counterparts in the US, according to Morningstar.

“While US equity flows have long favoured passive products, international-equity and bond-fund flows have followed suit, helping to get passive funds over the hump,” it stated.

Growth of Index Funds
Source: Morningstar

UK investors have also been embracing passives. According to the latest Investment Association data, £2.7bn was put into tracker funds during November 2023 – the highest since April 2021.

This increase means index portfolios’ overall share of industry funds under management now stands at 22.2%. This compares to 15.7% in November 2018, when £188.1bn was invested in trackers.

Of course, the type of index funds available in different markets has changed over the years as new products have become available to investors.

For example, the number of S&P 500 index funds has decreased from 118 back in 2000 to 77 at the end of 2022, according to Statista.

S&P 500 index funds has decreased from 118 back in 2000 to 77 at the end of 2022
Source: Statista

The Bottom Line: Should I Invest in Index Funds?

Index funds are potentially suitable for everyone, whether you are a first-time investor or someone with many years of experience behind them.

They are a low-cost, (relatively) stress-free way to invest in diversified stock markets or specific sectors without having to make asset allocation decisions.

They can also give you access to an area without you having to spend months researching the individual constituents of a market.

If you believe a particular index will rise over the longer term, then it makes sense to consider a fund that will give you exposure to that performance.

This could be particularly useful if you want a stable, core holding for your overall portfolio that is invested in well-established global companies.

However, the final decision comes down to your investment goals. If you want the potential for high returns – and you’re willing to embrace risk – then consider an active fund instead.

Do your own research and always remember your investment decision depends on your attitude to risk, your expertise in the index funds market, the spread of your portfolio, and how comfortable you feel about losing money.

The information in this guide does not constitute investment advice and is meant for informational purposes only.

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Rob Griffin
Financial Journalist

Rob is a seasoned journalist with over three decades of experience spanning across business and finance journalism. Before embarking on a freelance career in 2002, he contributed his expertise to the business desks of notable publications such as the The Guardian, Yorkshire Post, Sunday Business (now Business Post), and Sunday Express. Throughout his freelance journey, Rob has been a regular contributor to a wide range of national newspapers, consumer magazines, trade publications, and websites. His work has appeared in titles such as The Independent, Citywire, Daily Express, FT Adviser, and Sunday Telegraph, covering an array of subjects from market trends…