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How To Start Investing In Index Funds

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Everybody knows they should be investing, but the truth is most of us aren’t investing nearly enough– and that’s if we’re investing at all. Investing can be scary, especially if you’re new to it. 

If you’re new to investing, this blog is for you! We’ll go over index funds, which are my favorite way to invest!

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What is an Index Fund?

In order to start investing in index funds, we need to establish an understanding of what index funds are. 

When I think of index funds, I think about cookouts in my early twenties where everybody brought a dish. Back then I didn’t have a lot of money, so I would always plan to bring something less expensive like napkins, drinks, chips, cups… you get the drift.

I had a few grocery store options when it was time to shop for what I needed. I could stop at Walmart, Target, Kroger, AGB or any other grocer in my general area.

This particular part of the story carries over into the investing world. The grocery stores are brokerage firms. These brokerage firms have different types of accounts that you use to make purchases, and just like grocery stores, there are plenty of things you can purchase at a brokerage firm.

Just like you may have a favorite grocery store, I have two favorite brokerages firms: Vanguard and Fidelity. 

I like these two particular brokerage firms for a few reasons:

  1. Their investing options are equal to pretty much anyone else.
  2. Their websites and apps, are more user friendly, which can be important when you’re new to the investing game. 

Once I’m in the grocery store, I can head straight toward the snack aisle to buy the chips that I need to bring for the cookout.

I get to the aisle and I see Doritos, Cheetos, Baked Lays, Fritos, and many more options. 

It’s at that moment, standing in the snack aisle, that I would realize I have no clue what I should buy.

I mean, I’m personally a Doritos guy, but what if the cookout crowd is a Cheetos crowd? What about the random folks that love Fritos? I don’t want to look like an idiot by getting the wrong thing and wasting my money. 

Maybe that’s how you feel about investing in the stock market. You know you need to buy something, but you don’t know which decision is the best one for you in your situation. You feel a little stuck, right? 

So, if you watch the news, Apple is booming. So should you go with Apple? Tesla’s been tearing it up lately, right? Should you buy stock from them? What about stock in the company you work for?

What do you do? Well, it’s pretty simple. 

If you care deeply about grabbing that wrong bag of chips at the grocery store, you do what I do: You grab one or two variety packs. You purchase an item that ensures everybody’s covered and everybody’s happy. 

What the variety pack does is it lowers the risk of you walking into the cookout looking like an idiot with the wrong bag of chips. 

In the investing world, the variety pack of chips is what we call an index fund.

In the same way that there are tons of variety pack options for chips, there are also tons of index funds options for investors.

By purchasing index funds, you essentially own a whole group of stocks or bonds– or even both. That variety lowers your risk of picking the wrong investments.

Some of the stocks will be hits, like Doritos and Cheetos, while you may get a few Fritos in the bunch. 

There are tons of index funds you can choose from. There are international index funds, which hold companies doing business outside of the US. There are tech index funds that only hold tech companies. There are even “small and medium cap,” index funds that hold smaller and medium sized companies. 

What is my preferred Index Fund?

My personal favorite is a total stock market index fund. A total stock market index fund would be like if Frito Lay made a list of their best selling chips and they put a few of each of these in the variety pack based on their popularity and how many units sold.

They’ve got every popular chip they make in one pack and you really couldn’t go wrong with that for a cookout. 

By investing in the US total stock market index fund over the long term, I’m making a relatively safe investment because I’m essentially buying a piece of every publicly traded company that has, on average, gone up in 10 and 20 year increments.

You may buy a few companies that go out of business, but in that mix you may also be able to crush it with stocks like Apple or Microsoft. 

So how do you know what a good index fund is and what isn’t?

An important thing to remember when investing is that past performance doesn’t determine future results.

What that means is just because something made somebody else a lot of money last week, last month or last year doesn’t mean it’s going to happen for you if you buy the exact same investments.

Instead of chasing past performance, focus on things that do matter, like freeing up cash flow so that you can invest consistently and watching expense ratio. 

What are Expense Ratios?

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The expense ratio is the fee that all funds charge shareholders like you or me. Expense ratios matter because every dollar you pay out in fees is a dollar that could have grown over time in your brokerage account. 

It’s very important whether you’re doing a 401k or a Roth IRA or whatever you’re investing in, that you look at the expense ratios of anything that you buy. 

For example, one of my favorite index funds is Fidelity’s FSKAX. It has an expense ratio of 0.02% however, there are actively managed funds with expense ratios sitting around 2.5%.

If you bought $10,000 worth of both of those funds and you waited 30 years where you never contributed another dollar, the expense ratio of the actively managed fund could cost you around $29,000 more than the index fund.

We’re looking at 0.02% two point percent and you may be thinking that 0.02% isn’t a big deal, but $10,000 over 30 years, is going to cost you $30,000. 

I’m not only paying the fee, I’m also losing out on the growth that the money in fees would have made as well. 

That’s the important part of expense ratios– the opportunity cost. So again, always be aware of your expense ratio when you’re investing, especially with your 401k because they’ve been known for having high fee

The most popular accounts are 401ks, traditional IRAs and Roth IRAs. Even ‘regular’ brokerage accounts are used often for index fund investing.

401ks are offered through employers and their tax advantaged IRAs are also tax advantage, but you can actually open those by yourself. 

How do Index Funds Work?

Once you decide on the account, you’re going to fund it with money and then you’re going to use that money to buy low-fee index funds. The low-fee index funds are the variety pack that hold the individual stocks. The brokerage firm is going to hold your account and your account is going to hold your index fund. The index fund is going to hold individual stocks and that’s how buying index funds works.

Read The Transcript

Michael Lacy (00:00): Everybody knows they should be investing, but the truth is most of us aren't investing nearly enough and that's if we're investing at all and I get it. Investing can be super scary, especially if you're new to it. So as a followup to last Wednesday's episode where my friend Jay shared how he invested his way to 700 K by age 26 I figured I'd help you get a better understanding of index funds, which just so happened to be my favorite way to invest as well. So let's get to it.

Michael Lacy (00:44): [inaudible] [inaudible] quick

Michael Lacy (00:44): disclaimer. In this episode I'll probably throw out some company names, some actual index funds, some types of accounts and more. This is not me advertising for any of those companies or any of those things. I assure you that I'm not being paid for any of this by any of these companies. And I'm also not recommending any of this for you personally. This is not me advising you. This is just general information that I've learned over the years and that I've personally implemented from my household. That's it. So jump right in. I mean, in order for you to start investing in index funds, we first need to establish an understanding of what index funds are. And so when I think of my investing style now I think back to cookouts in my early twenties where everybody was supposed to bring something to eat, right? And so back then I didn't have a lot of money, so I would always plan to bring something less expensive like napkins, drinks, chips, cups, whatever.

Michael Lacy (01:41): You know, I was, I was totally that guy. Right? And so now here in Houston, I had a few grocery store options when it was time to shop for what I needed. So I could stop at Walmart, I could stop at target, Kroger, or even AGB. And so this particular part of the story carries over into the investing world. Except the stores are not called stock stores, like they're called grocery stores, which I mean, I think it would've made it a lot simpler. But instead they're called a brokerage firms. And these brokerage firms have different types of accounts that you use to make purchases. And just like grocery stores, there are plenty of things you can purchase at a brokerage firm and just like you may have a favorite grocery store. My two favorite brokerages happen to be Vanguard and fidelity. Now this is for a variety of reasons and I'll say that I personally use fidelity for a few reasons.

Michael Lacy (02:34): Number one, because the investing options that I have with fidelity equal pretty much anyone else. So that kind of levels the playing field in my opinion. Uh, and to well their website and their app, they're just way more user friendly. Uh, which can be important when you're new to the game as I was when I signed up. So anyway, back to the cookout analogy. So once I'm in the grocery store, right, I can head straight toward the chip out to buy the chips that I need to bring for the cookout. Right? And so I get to the aisle and I see Doritos, I see Cheetos, I see lays Fritos, and of course the generic brands of these and so many more options. Right? And it's then that I would realize, shoot man, like I have absolutely no clue what I should buy right now. I mean, I'm personally a Doritos guy.

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Michael Lacy (03:23): But what if the crowds a Cheetos crowd and what about those random, you know, two and a half folks that love Fritos, right? Like I don't want to look like an idiot by getting the wrong thing and wasting my money. So maybe that's how you feel about investing in the stock market. Like you know, you need to buy something, but not knowing which decision is the best one for you in your situation probably has you feel a little stuck, right? So I mean if you watch the news, it's like Apple is booming, right? So should I go with Apple and I mean Tesla's been tearing it up lately, right? Or, or what about stock in the company that you work for? I mean, let's face it, making the wrong investment for your retirement is a lot more risky than showing up to the cookout with ruffles and hoping things go well.

Michael Lacy (04:09): Right? So what do we do? Well, it's pretty simple. I mean, if you really, really care deeply about grabbing that wrong bag of chips at the grocery store, you do what I do. And you grab one or two of those boxed variety packs, right? The ones that have the Doritos, the Cheetos and you know, all that stuff all in one little box. And so you make sure everybody's covered and everybody's happy. You see what the variety pack does is it lowers the risk of you walking into the cookout again looking like an idiot with the wrong bag of chips. So you covered the cool ranch and the nacho cheese Doritos folks, right? You get the, the Cheetos person taken care of and you even throw in a couple of those Fritos for the two and a half people that care about those. And um, in the, in the investing world to kind of bring this back home, the variety pack of chips is what we call an index fund.

Michael Lacy (05:00): And in the same way that there are tons of variety pack options. Now you've got the Doritos, you've got the hot ones, you've got, I mean just all these different types of variety packs. There are also tons of index funds and so by purchasing index funds what happens is you essentially own a whole group of stocks or bonds or even both. And so that kind of lowers your risk of picking the wrong thing. And so some of the stocks will be hits like Doritos and Cheetos and again you probably get a few Fritos out of the bunch. But like I said, there are tons of index funds. I mean you have the international ones which hold companies doing business outside of the U S you have tech index funds and only hold tech companies and you have what's called small and medium cap that holds smaller and medium sized companies.

Michael Lacy (05:47): And there are a few more, but you can pick and choose however many you want and all the different baskets you want. But my personal favorite is a good total stock market index fund. Now a total stock market index fund would be like if Frito lay made a list of like every chip that they've sold a ton of and they put a few of each of these in the variety pack, right? Based on their popularity and how many of these they sale. Now imagine that, right? They've got like every chip that they make, every popular chip they make in one pack and you really couldn't go wrong via in that for a cookout. And so by investing in the U S total stock market index fund over the long term, I'm making a relatively safe investment because again, I'm essentially buying a piece of every publicly traded company, AKA the American economy, which has pretty much done nothing but go up when looked at in 10 and 20 year increments.

Michael Lacy (06:48): Like, yeah, sure, there've been times where we've had these little runs where a year here, two years there or whatever. But when you step back and you look at it in 10 20 year increments, pretty much everybody that's gone this route has won. And so yeah, you may buy a few companies that go out of business, kind of like those, uh, those 3d Doritos that used to come in the little plastic cylinder thing. Um, but in that mix you may also be able to just crush it like with the next Apple or Microsoft, Google or something like that, you know, so, so how do you know what's a good index fund and what is it? Well, an important thing to remember when investing is that past performance doesn't determine future results. And so what that means is just because something made somebody else a lot of money last week, last month or last year had doesn't mean it's going to happen for you if you buy the exact same investments.

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Michael Lacy (07:41): So instead of chasing past performance, focus on things that do matter, like freeing up cashflow so that you can invest consistently and also watching the expense ratio. Um, and let me go into that. The expense ratio is the fee that all funds charge shareholders like you or me. Um, expense ratios matter because every dollar you pay out in fees is a dollar that could have grown over time in your brokerage account. So it's very important whether you're doing a 401k or a Roth IRA or whatever that you look at the expense ratios of anything that you buy. So for example, one of my favorite index funds is Fidelity's FSKAX. It has an expense ratio of 0.02% however, there are some actively managed funds with expense ratios sitting around two and a half percent. And so let's break this down. If you bought $10,000 worth of both of those funds and you waited 30 years, you never contributed another dollar, the expense ratio of the actively managed fund could cost you around $29,000 more than the index fund.

Michael Lacy (08:52): So again, we're looking at 0.02% two point percent and you may be thinking like, Oh, that's not a big deal, but $10,000 over 30 years, that's going to cost you $30,000 right? And so listen, because I'm not only paying the fee, I'm also losing out on the growth that the money in fees would have made as well. So that's the important part of this whole thing. So again, always be aware of your expense ratio when you're investing, especially with your 401k because they've actually been known for having pretty high fees. And so as a matter of fact, a great assignment for you this week is to check the expense ratio on your 401k because again, super notorious for having high fees. So to recap this, you're going to first need to pick a brokerage firm or stock store if you want to call it that. From there you'll decide which type of account you need to open at the brokerage firm to hold your stocks.

Michael Lacy (09:46): So the most popular accounts are going to be traditional and Roth 401ks traditional and Roth IRAs or even just a regular brokerage account. And so 401ks are offered through employers and their tax advantaged IRAs are also tax advantage. But you can actually open those by yourself. And irregular brokerage is also another one that you can open by yourself. But it actually has no significant tax advantages. So once you decide on the account you're going to fund it with money and then you're going to use that money to buy the low-fee index funds. And the low-fee index funds are the variety pack that hold the individual stocks that you hear about all the time. So the brokerage firm is going to hold your account and the account is going to hold your index fund and the index fund is going to hold individual stocks and that is how buying index funds works.

Michael Lacy (10:43): So if you learn something from this episode and you just want to show appreciation or support the show, there are a few ways you can do that currently. First, you can hit the subscribe button wherever you're listening to this. So you can always be notified of any new episodes when they released. The second way you can support the show is to leave a five star review. If you're listening to this specifically on Apple podcast, this lets potential listeners know that we do share valuable content on the show and this also helps the show grow and ultimately help more people. Which is my personal goal. And so finally, you can always just hit the share button and post this episode on social media. So those are the three ways right now that you can really help the show grow and show appreciation and say, thanks. So whatever you decide to do, I'll definitely be more than appreciative. But thanks again for listening to another money talk Monday segment and we'll talk soon.

Michael Lacy (11:48): [inaudible].

Resources Mentioned

Fidelity

Vanguard

 

 

 

 

 

Are you new to investing? Check out this post where I share how you can get started investing in index funds-which have proven to be one of the top ways to invest in the stock market. I also detail what index funds are.

Index funds are an incredible way for new investors to get started. DIY investing in index funds can come with lower fees and expenses than working with an advisor. Learn more about index funds.

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