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How to Become A Millionaire: Index Fund Investing For Beginners

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A comprehensive Guide to Index Fund Investing.

Your full Guide to Index Fund Investing

If you want to be a successful investor in the long term, index fund investing is one of the best ways. You have less risks, and still in the long term you most likely achieve better returns than by picking individual stocks.

Did you know that every year more than half of actively managed funds fail to beat the market?

That’s why I’m going to explain here everything you need to know to successfully start Investing in Index Funds.

What is an Index Fund

So what are index funds, what is the difference with mutual funds or ETFs, and why are they better than investing in single stocks?

When you invest in the stock market you can choose to buy shares of specific companies, which are pieces of ownership of that company.

If you buy a share of Microsoft, which is valued now at around $410, you own a little piece of the company. So you’re officially a shareholder. Problem is, there are almost 4000 companies in the American stock market, and while some of them might make you rich, like Nvidia did in the last decades, many of them lose value and some of them even die a slow death without ever getting back on track. And with over half of competent, resourceful investors populating investment banks failing to beat the market, you gotta wonder if you really want to try your luck. 

But don’t worry, Index Funds solve this problem for you.

When you buy a share of an Index Fund you’re buying a package that contains several companies, usually hundreds or even thousands. There are Index Funds for basically everything. For different sectors, different countries. For example you can buy an index fund that contains all big companies in the technology sector. Or for all the companies of the United States. Or even for crypto, or Real Estate.

Some companies within the index will perform poorly, some better, but since you own them all, your portfolio will grow in the long term and the probability of losing your money becomes close to zero. 

To give you an example, the index called S&P500, which includes the 500 largest companies of the american economy, grew with an average of 9.9% since 1928 through the end of last year, and 10.26% from 1957, showing positive results most of the years with just a couple of exceptions.  

Index Funds vs ETFs

You might have heard of ETFs.

ETFs are also index funds, but a particular type.

ETF stands for Exchange Traded Fund and the main difference with traditional index funds is that you can buy ETFs anytime during the day, which is an advantage if you want to buy and sell many times during a day, while index funds can be bought only once a day at the price they reach when the market closes.

The main disadvantage of ETFs compared to traditional index funds is that since you can buy them and sell them during the day on the market, there is a so-called spread between buy price and sell price. So let’s say that an etf has a price of $100 and has a spread of 2%, if you buy it you need to spend $101 and if you sell it you gain only $99. The bigger the ETF, the more people are buying and selling all the time and the smaller this spread becomes. So for large ETFs like the ones I usually suggest in my channel spread is not actually going to be a problem but still, Index funds, as opposed to ETFs, will always price at the net asset value without spread, so that’s an advantage.

A disadvantage of Index funds is instead that often there is a minimum investment threshold, which can be $1,000, $3,000, in some cases even $10,000, which is the minimum value that your portfolio must have, while for ETFs there’s usually no limit. ETFs are totally fine and if you want an introduction to ETF Investing you can watch this video of mine that explains everything you need to know:

Index Funds vs Mutual Funds

Mutual fund is another term you might have heard of, and as opposed to index funds that passively follow an index, a mutual fund is actively managed by a fund manager who decides what to sell and what to buy within its fund. This means that:

1) You will pay much higher fees

2) The performance will most likely be lower than the one of the index fund because most actively managed funds fail to perform better than the market almost every year.

Advantages of Index funds

So, it’s clear that index funds are for most people a better solution than stock picking because they diversify your portfolio giving you access to hundreds of companies and sectors without having to buy all the single companies yourself.

They are also a better solution than mutual funds because since they are passive they have incredibly low fees and tend to perform better than actively managed funds  because there is not a person with emotions involved in the selection of the companies.

The Best Brokerage Accounts

Now let’s move first to how to actually start investing and opening a brokerage account.

The process of investing is literally just going to be moving some money from your checking account to an investment account and buying an ETF or a stock with a couple of clicks. It’s actually pretty easy.

These are some of the most common brokerages, or investments accounts, that you can open, no matter what country you’re from:

For the U.S. the most common investment brokerages are Schwab, Fidelity or Vanguard, but most young people use Apps like Webull or Robinhood which are also completely fine.

If you come from or UK you can use Trading 212 and from Europe also Trade Republic, and if you use this link, you’re going to get a free stock with a value of up to $100 by signing up.

Depending on your country, with these brokers you’re going to be able to open a normal investing account or also tax advantaged accounts. For example if you live in the US, you should absolutely profit from a Roth IRA, which is an investing account that makes your investments grow tax free and you can withdraw them tax free if you wait until you are 59 years and a half of age. The only limitation is the amount you can invest every year which is $7,000 if you’re younger than 50, otherwise $8,000.

Another interesting account in the U.S. is the 401(k), which is a workplace retirement plan that lets you invest annual contributions up to a certain limit and the employer also matches your contribution up to 100%. 

In the other countries you may find similar conditions, for example an equivalent of the Roth IRA in the UK is the ISA, in Canada TFSA, Super in Australia.

Now Let me guide you through opening an account with Vanguard, through the website, and Webull, through the app.

Opening a Vanguard account (Website) 

On Vanguard’s Personal Investor homepage, you need to select “Open an account”:

Assuming you’re going to be using your bank to make your initial investment, you’d select the first choice:

After clicking sign up on the “I’m new to Vanguard” option, you’re shown an overview of the next steps and the whole process of opening an account will take you 5 to 10 minutes.

Then you need to select the type of account you want. The first is the IRA, like a traditional IRA or a Roth IRA, and the second is a normal investing account.

You’re going to be asked for the typical information like address, phone and so on. Remember that investment accounts are like banks, so they need to ask you this information just like a bank would.

Some questions might seem inappropriate to you, like info about your employment, income and net worth, but they have to do it just because it’s required by law.

Once your account has been accepted within 3 to 7 days and your money reaches your new account, you can start investing and you’re going to be able to buy etfs, index funds, and even stocks.

Opening a Webull account 

Vanguard does also have an App, but to show you how to set up a brokerage from your phone I’m going to use Webull. By the way, the process of creating an account and buying ETFs is the same for all brokers, so if you know how to do it with one you’re going to manage with any broker.

Step 1 is download and open the Webull app on your phone. Click on Open Account located at the bottom of the screen and then you’ll have to identify using an ID.

Step 2 is filling in your personal information as they appear on your ID, and then your employment information, just like we’ve seen from Vanguard. You then answer some questions about your investment objectives, your finances and you confirm.

The next step is to choose your account type. Choose “Cash Account”, because right now you don’t want to deal with margins, and choose stocks and ETFs as securities. Webull usually requires 24h to review your application and then you’re going to be ready to go.

The 10 Best Index Funds

Here are 10 of the best index funds that you can buy if you are starting an index fund portfolio.

You don’t need to buy all of them. Most people use one, two or three of them because they are all pretty generic market index funds with great diversification.

The first two are just two versions of the S&P500, namely a collection of the 500 best and largest companies of the U.S. Economy. The abbreviation you see is called ticker and it’s like a unique code for that index fund.

If instead of the index fund you want the ETF version, for Vanguard it’s going to be VOO for the U.S. or VUAA for Europe. If you are from Europe I suggest you just write the whole name, like Vanguard S&P500 instead of VUAA, because depending on the country and market the ticker changes so it’s safer to look with the whole name.

After the S&P500 I’m going to give you FNILX, the Fidelity ZERO Large Cap Index Fund. This is a really interesting fund because it’s similar to the S&P500, even in performance, but has zero fees.

Then we have the total stock market with VTSAX, which has a really similar performance to the S&P500 but includes all 3750 companies of the stock market, so it’s going to give you even more diversification.

Usually, even just buying the S&P500 or the total stock market in the long term you’re going to have a better performance than 80% of investors so you might even stop there.

Then you find VIGAX, a growth index fund, and VVIAX, a value index fund. Growth represents companies that invest aggressively into their growth while value are usually more mature companies, that tend to invest less in growth and distribute their earnings more to the shareholders through dividends.

Then I’m giving you VBTLX, which is the total bond market from Vanguard.

Discover the best Index Funds 

Now let’s see how to find index funds on the Vanguard website and how to choose the best ones. And by the way with other firms like Fidelity or Schwab it’s going to be the same thing. So if you google Vanguard index fund list you get here in the list of mutual funds and as you can see on the left you have different filters you can use. The first important thing is, we want index funds and not actively managed mutual funds, so you go to management style and you choose Index. Alright on the right side you can turn on the detailed view, so that we get a little bit more information about the funds. An important information is the expense ratio, which is the amount of your portfolio that you’re going to pay as fee every year and usually good index funds like S&P500 or total stock market index funds are under 0.1%. Then you can see the performance in different time frames and the investment minimum that you need to start investing in that index fund. 

Usually, when investing in Index funds, I suggest you go for the most common ones, like the ones I listed before. If you invest in ETFs instead, which by the way is what I do and what I mostly talk about in my channel, there are many tools online that help you finding the best one and to learn more about how to do this you can watch this video of mine where I set up a free ETF screener and teach you what are the most important things to look for when choosing ETFs:

Fund Overlap

Another important thing to know is the concept of fund overlap.

Since index funds and etfs are baskets of different stocks, if you buy more than one ETF it might happen that they have overlapping positions.

This is not necessarily a bad thing, for example you can have a total stock market index fund that has all the companies and then you want to have more weight on a particular sector and you buy an index fund of that sector. In this case, obviously the second index fund is going to have a huge overlap with the total stock market but you are doing it with a purpose.

Etfrc.com offers a Tool to check the Fund Overlap between two funds. Look for example what happens when we use it to compare VOO, the S&P500 from Vanguard, with QQQ:

Using the tool you find that 84 holdings are included in both ETFs, 16.6% of VOO’s 500 holdings are also in QQQ, and 84% of QQQ’s 100 holdings are also in VOO. When comparing by weight, there’s a total overlap of 45%.

Fractional Shares

When you look for an ETF or a Stock to buy in your investment account, you’re going to find the unit price, the price of a single unit.

For example the S&P500 ETF from Vanguard is trading at around $462:

This price has absolutely no meaning to you.

Why is that? Because since a couple of years we have the option to buy so-called fractional shares. So instead of buying a whole unit for the market price, you can buy a small portion of it for like $1.

This is the major reason why you shouldn’t care about the unit price of an ETF, but it’s not the only one.

Another reason is that the unit price doesn’t give you any information about the value of an ETF or Stock. It’s not like the price tag of some shoes. And the reason is that when a company goes public and gets valued a certain net worth, they decide in how many shares they want to divide this value.

So let’s say that a new company goes public and gets valued at $1 Billion. They can create a billion shares, each valued $1, or they could create 2 shares, each valued half a billion. So the value of a single share doesn’t tell you anything about the value of a company. It was relevant in the past because you were forced to pay at least that amount because you couldn’t buy fractions of a share, but not anymore.

How much should I invest?

The answer depends on your income and your final goal, but to help you define how much you need to invest I prepared a google sheet which I’m going to make available to you for free through this link.

This table tells you how your portfolio is going to grow depending on how much you invest.

Let’s say you start with an initial capital of $0, and you want  to invest in the S&P500 that as I said for the last 100 years gave an average annual return of 9-10%. Let’s put 9% here:

Now this is where it gets interesting, because by writing how much you’re going to invest every month, you can see how much your wealth grows every future year. For example if I invest $500 every month, after 10 years I’m going to have $96,757.14. After 20 years $333,943.43. After 40 years, I have over $2.3 Million, and this having only invested $240,000 in a lifetime.

You can download the google sheet completely for free from this link.

When should I start?

Another question that everyone asks is “When should I start?” and the question usually comes up because we always have the fear that the stock market has grown too much and a crash is coming and we are going to lose all our money.

To answer this I’m going to show you a really interesting study by Schwab. Schwab proves that trying to time the market is always a bad choice and instead you should start investing as soon as possible.

The research studies the performance of five hypothetical long-term investors following different investment strategies. The 5 ideal persons are Peter Perfect, Ashley Action, Matthew Monthly, Rosie Rotten and Larry Linger. Each received $2,000 at the beginning of every year for the 20 years ending in 2022 and invested the money in the S&P 500.

Peter Perfect was a perfect market timer and was able to place his $2,000 into the market every year at the lowest price of the year. 

Ashley Action took a simple, consistent approach: Each year, she invested her $2,000 right away.

Matthew Monthly divided his $2,000 into 12 equal portions, which he invested at the beginning of each month using the dollar-cost averaging method.

Rosie Rotten had incredibly poor timing—or perhaps terribly bad luck: She invested her $2,000 each year at the worst, most expensive moment of the year.

Larry Linger, well, Larry left his money in cash. He was convinced that it was better to wait for the next crash before investing, so he ended up never investing his money.

Here’s the wealth of our 5 friends after 20 years:

There are many conclusions you can draw from this, but the most interesting is that even Rosie Rotten, which always invested in the worst moment of the year, ended up with double as much money as Larry which didn’t invest at all. And the difference with Peter, which always invested in the best moment of the year, isn’t even so big.

Index Funds or ETFs?

In case you are more interested in ETFs, you can watch my full guide for beginners as a video here or as a blog post here.

You’re going to find a lot of interesting material in my Investing channel, so check it out!

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