How to Buy Index Funds

In theory, buying index funds is quite simple… You just open an investment account, transfer some money into it, and buy the fund!

But as new investors dive into these steps, a bunch of little questions pop up which can complicate the process…

• Which broker should I use?
• What account type is best?
• Are all index funds the same? 
• And what about fees, taxes, dividends and all those other confusing investment terms people talk about?

Good news… These are all things we’re going to address in this post!

Buckle up – By the time you’re done reading you’ll not only know how to buy index funds, you’ll be able to teach your friends how to easily do it too!

How to Buy Index Funds (process overview)

Don’t lose sight of how simple the process actually is. Open account —> put money into it —> invest.

You’ll see we added extra steps, but this is mostly color context to help you set up a successful system for long term investing. 

At a glance, here is a basic overview of how to buy index funds:

**BTW – If you’re completely new to investing, might we suggest you start with our Investing 101 Beginner’s Guide. It’s a 10 minute read and will give you a better overall foundation for why index investing is awesome and why so many people recommend index funds in the first place!

1) Pick a Broker

The first step to buying index funds is figuring out which broker to partner with. The term “broker” is just a fancy name for big finance companies that are licensed to buy/sell/trade public investment products.

Think of brokers just like banks. When choosing one, you want the lowest fees possible, a wide range of investment products, and good customer support.

The 3 biggest discount brokers in the world are:

• Vanguard
• Fidelity
• Charles Schwab

Here’s the best part… ALL 3 of these brokers offer no-fee accounts, no trading fees (to buy their specific index funds) and are very easy to use. We recommend these brokers all the time, and they are often the perfect choice for beginners.

If you’re already working with a broker, or have a trading account with a fin-tech company like Robinhood, Ally, Betterment, M1 or SoFi, that’s totally fine too. For the purposes of buying index funds, most brokers can get the job done in similar fashion. But the reason we recommend the biggest companies is because they not only host investing accounts, they also manage the actual index funds you’ll be buying. (We’ll explain more in #5)

Don’t worry, you can always change brokers or move your account around later. Just like banks, brokers host your account, but you are the legal owner of the money and funds inside of it.

** BTW — if you’re buying index funds inside of your 401(k) (or another workplace retirement account), the broker is selected by your employer. You don’t get the luxury of choosing your own broker. Ask your HR department which benefits provider they use and they’ll direct you to the broker they work with.** 

2) Choose an Investing Account

The next step to buying index funds is figuring out what type of account you want to own them in.

While there are many different account options in the investing world, to keep things as simple as possible we’re only going to cover the 3 most common ones. These are 401(k)s, IRAs, and regular brokerage accounts.

401(k)’s and IRAs are the lowest hanging fruit options available to the majority of people. They offer great tax advantages and are perfect for beginner investors – and often seasoned ones too! Regular brokerage accounts don’t have tax advantages… but, they offer the most flexibility for growing wealth because there are no income or contribution limits and fewer rules to follow.

Eventually, you’ll want to spread your investments across multiple account types. That lets you take advantage of all the goodness each has to offer. But if you’re just starting out and new to investing, focusing on one is a great way to begin. And that often means your workplace account, especially if you have an employer match available to you.

Workplace 401(k) plans

A 401(k) plan (or 403(b) for nonprofit or government employees) is a workplace sponsored retirement plan. This means that your current job either offers one, or they don’t.

If your employer offers a 401k plan, that’s awesome! You should ask your HR department about setting one up ASAP. If you don’t have access to a 401k, don’t worry… just jump right to the other account types.

401ks have many benefits, but the main ones are:

• Paycheck deductions: The money you put into your 401k gets taken out of your paycheck, giving you an ”out of sight, out of mind” advantage. It’s waaaay easier to invest when your contributions are on auto-pilot.
• Tax deferring: The money going into traditional 401k accounts is pre-tax! This means it lowers the amount of income tax you pay during your investing years. (Of course, you eventually will be taxed on that money, but usually a smaller amount, when you retire)
• Employer matching: As an incentive to save more, many companies offer a 401k matching program. This means they will put extra money in your retirement account – all you need to do is contribute the minimum amount required. This is FREE money, so if you have this option, TAKE ADVANTAGE OF IT.

We’ve written a full post about the pros and cons of 401(k) plans. Check it out if you’re unsure if investing in your workplace plan is right for you.

IRAs and Roth IRAs

IRA stands for Individual Retirement Account, and there are two different types: Traditional and Roth.

While both of them come with tax advantages, most people benefit more from contributing to a Roth. That’s because once you invest money inside a Roth IRA, you won’t have to worry about the money inside that account ever being taxed again. The account can grow and grow, and when you take the money out in retirement, you can withdrawal it all tax free.

Roth IRAs also have some early withdrawal flexibility! Anything you put in (your original contributions) you can take out with no penalties – at any time. This is an awesome benefit – but, we must warn you that taking money out of retirement accounts before retirement isn’t the wisest move. To fully see the growth benefits, leave that money invested for as long as possible!

Two small catches to Roth IRAs:

• Income limits: In 2024, if you make over $146,000 (or $230k for married folks) then you are not eligible to put money in a Roth IRA.
• Contribution limits: In 2024, the maximum you can contribute to an IRA is $7,000 for the year. This applies to both Roth and Traditional IRAs.

We’ve dedicated a full post to traditional IRAs vs. Roth IRAs. Check it out if you’re not sure which one is best for your situation.

Plain ol’ Brokerage Accounts

If you’re looking for an account with no restrictions, no limits, and the most flexibility, this is the account for you.

But, we must stress two important warnings about brokerage accounts…

First, brokerage accounts sometimes don’t really feel like “retirement” accounts because you can put money in and take it out whenever you like. The downside is, this encourages “trading” and moving investments around – which is a big no no if you’re trying to build long term wealth! You should only be investing money and buying index funds if you plan to leave it untouched for decades. No trading! That only erodes your nest egg, trust me.

Next, we can’t overstate the importance of prioritizing tax-advantaged accounts. Before you invest inside a regular brokerage account, be sure to fully take advantage of your 401(k) and Roth IRA options. Max those suckers out first before investing elsewhere.

That being said, regular brokerage accounts offer the most flexibility when investing. If you plan to retire early, or have excess income to invest beyond retirement account limits, a plain old brokerage account becomes a no-brainer choice.

Again, Fidelity, Vanguard and Schwab are three of our favorite brokers to consider opening an account with.

And remember, the main goal of choosing a broker and setting up an account is: incredibly low costs and no monthly fees!

3. Transfer Some Funds

Once your account is open, you need to transfer money into it! This is the money you are going to use to buy index funds.

If you’re investing in a 401k, you’ll nominate how much money will be pulled out of each paycheck. Remember, if your employer offers a match, make sure to contribute enough to qualify for the full match amount. Once you’ve set up your 401k contributions, the transfers will then happen automatically going forward.

For any other account type, you’ll need to manually transfer money – at least for the first time.

The best way to set up money transfers is by connecting your brokerage account with your regular bank checking account. The broker will keep your routing number and account number on file, that way any future money transfers are simple.

Note for Roth IRA investors: When transferring money into a Roth account, the broker will keep track of how much money you are contributing each year to make sure you don’t accidentally go over the annual limit. Again, for 2024 the limit is $7,000 – so you won’t be able to transfer more than that within a single year.

4. Set Up *Recurring* Transfers

Who do you think grows more wealth…  a) someone who invests $5,000 all at once and then doesn’t touch it for 40 years… Or b) someone who invests only $25 per week, every week for 40 years?

I think you guessed it. It’s the person who invests slowly and consistently over time. Buying index funds won’t cause you to get rich quickly. But you can build an absolute fortune over time if you invest incredibly consistently.

So, after you make the initial deposit into your investment account, take it one step further and commit to regular monthly contributions. Even if it’s just a small amount to begin with, it all adds up!

How much should you invest each month?

Here’s a cool chart showing how long it takes to reach a $1M milestone, by contributing within specific accounts each month.

If you’re maxing out your 401(k) by contributing ~$900 per paycheck, you’ll have a cool million dollars in 20 years.

Becoming a Roth IRA millionaire would take around 34 years, by just setting up monthly investments of $541.

You get the point. Putting your contributions on auto-pilot means you never have to worry about investing. Your wealth will just grow like clockwork in the background!

5. Buy Broad, Low-Cost Index Funds

OK, we’re finally up to the point where you can actually buy index funds! You’ve got an account set up, with money in it, and you’re ready to click “trade” and buy funds.

Which index funds should you buy?

For the safest and best long term growth potential, you’ll want to buy index funds that have 2 important characteristics:

1. High diversification (aka “broad”): Index funds are basically big pools of stocks/bonds. The bigger the pool, the more diversified it is. For example, the S&P500 index fund has 500 companies inside it, made up of the biggest 500 companies across 10x industry sectors. (That’s very broad!) A total stock market index fund is even more broad.
2. Low cost: Index funds should be passive investments, meaning there is very little human interaction or management. So there’s no reason to pay companies massive management fees for doing nothing! A great expense ratio is 0.05% or less. That means if you have a $100,000 portfolio, it only costs you $50 per year in fees. (that’s cheap!)

By far, the most common index fund is the S&P 500. Like I mentioned earlier, it tracks the 500 largest companies across 10 different industries.

In fact, this fund is so common that many different brokers have created their own S&P 500 index fund. They trade under different names and symbols, but they are essentially the exact same thing..

For beginners that don’t want to worry about comparing funds or looking at all the expense ratios, we’ve made it incredibly simple… Below we’re going to cover the most common index funds for each of the biggest brokers. (we personally invest in these also!)

Index Fund Cheat Sheet:

Here’s a quick reference guide to help folks buy the right index funds…

A Total US Stock Market Index fund basically includes every single publicly traded company in the USA. Since many of the large USA companies (think Apple, Google, etc) also have a worldwide presence, there’s a bunch of international exposure that you incur by picking that specific index fund too. 

When buying index funds, it’s usually better to buy the fund that your broker offers in order to get the lowest fees…

For example, if your Roth IRA is set up with Vanguard, buy Vanguard index funds. Or if your 401(k) is managed by Fidelity, choose Fidelity index funds.

Again, since these funds all track the exact same index, their performance is pretty much identical!

Mutual Funds vs. ETFs

**This is getting into the weeds a little bit, so if you’re a beginner, feel free to skip over this section!**

All you need to know is that index funds can come in the form of ETFs or Mutual Funds. And some brokers offer the same index fund in both versions. For example, Vanguard’s total stock market index can be bought as a mutual fund (VTSAX) or as an ETF (VTI).

Here’s a quick visual of difference between ETFs and Mutual Funds:

The reason this distinction might matter when buying index funds is because some account types only let you buy mutual funds, not ETFs. In fact, if you’re investing in a 401k, you probably only have a handful of investment options to choose from and there’s a good chance your choices are mostly mutual funds.

Long story short: Pick funds that are offered by the broker you already have an account with!

Create a “buy” or “trade” ticket:

Once you know which index fund you want to buy, you’ll need to create an order ticket. This is basically you telling the broker to buy xxx dollars of xxx fund.

You’ll need to know the name of the index fund (or the ticker symbol) to complete the order. Here’s a screenshot from my Fidelity account… It shows an order to buy $3,000 of the index fund FSKAX inside of my Rollover IRA account..

If you’re extremely confused about all this stuff, another option is to call your broker and ask for help to buy index funds. But I must warn you that there can be a surcharge for having customer service complete a purchase order for you. Learning to do it yourself is always best!

Don’t worry, it’s not as complex as it all looks. There are tons of videos and guides for placing ticket orders for each broker.

Important note: If you have already set up recurring money transfers, you should also make sure that money is auto-invested into your preferred fund! Just moving money into an investment account doesn’t mean that it’s invested!

How Many Index Funds Should You Buy?

Many investors ask → “Is it ok to own just one index fund?”

It’s a great question, because if you own a fund like Vanguard’s “VT” (which includes every single publicly traded stock on the planet) you already have the maximum diversification possible with stocks.

But, what about bonds? Real estate? Or other asset classes?

Well, this all comes down to how much risk you’re willing to take on, and where you are in your investing journey. Traditional advice says you should start including bonds in your portfolio according to your age. But, if you own too many bonds while you’re young you’ll miss out on the higher long term growth that stocks provide.

Personally, I have no problem investing everything within one single index fund. I’m happy with a 100% equity allocation because I’m young and retirement is decades away. I’m shooting for the most growth possible.

That being said, as I approach retirement age and my portfolio gets larger, I’ll need to start shifting my strategy and think more about wealth preservation. This means buying bond index funds to smooth out the ride, or other assets (like buying a rental property).

Long story short → if you’re in the wealth building phase of your life, owning one index fund is completely OK. That simple approach often leads to the best results. But as you get closer to that retirement date, a 100% equity allocation often becomes too risky.

Target Date Funds

Speaking of investing in a single fund, there are already some managed funds available that automatically adjust your allocation over time as you get older. These are called Target Date Funds – and folks tend to choose one based on the year they anticipate retiring.

Target date funds are very common for 401k providers to offer. In fact, there’s even a chance that they might be the only option available to you.

While they sound great on the surface, it’s really important to check out the management fees of any target date fund you’re considering. While many of our favorite discount brokerages offer low-cost passive target date funds, many are actively managed, meaning there’s a team of investors behind the scenes buying and selling stocks/bonds based on what they think is right. This increases the cost significantly, eating into your returns.

But the whole point of buying index funds is passive management. So if you can buy index funds with lower fees and broad diversification, that might be a better play. But if you only have the option of target date funds, try to find the ones with the lowest expense ratio and a target retirement date that accurately reflects your risk tolerance.

6. Set up DRIP (Dividend Reinvestment)

Most index funds pay out quarterly dividends. This is usually a small amount of cash coming from your share of company profits.

By default, most dividends are paid as cash payment. And if you’re not careful, this cash just sits and accumulates in your brokerage account for years on end, not being put to work.

So we always recommend people turn on dividend reinvestment. Many brokers call this “DRIP”, and it’s typically a manual setting you need to opt in for. Here are the guides to set up DRIP at Vanguard, Fidelity and Schwab.

When dividends are reinvested, every dollar in your investment account can take full advantage of compounding over time.

As you can see, failing to turn this setting on can mean the difference of hundreds of thousands of dollars when you reach retirement age. So don’t forget this very important set when you buy index funds!

7. Sit Back and Relax

This is both the easiest, and hardest step of buying index funds.

It’s the easiest because hopefully you’ve set up automatic transfers each month and your money will continue to grow and compound into millions over time.

But it’s the hardest because waiting isn’t easy! Watching your balance go up and up might tempt you to pull some money out and spend it. Or on the flip side, watching your money drop in value during a market downturn might make you scared and want to sell investments.

Once you invest money in long term index funds, it’s really really really important not to touch it at all. The fewer transactions you make and the longer you leave your money invested, the more wealth you will build within the account. If checking your account is making you anxious, it would be wise to log in a whole lot less.

The Bottom Line:

Congratulations! You now know the process to buy index funds! It’s as easy as picking a broker, opening an account, selecting which funds you want to buy and putting the system on autopilot.

Hopefully you also learned a few things about lowering taxes, avoiding fees, and deciphering confusing investment terms. Now it’s time to pass your knowledge on to a friend, and get them investing too. Because growing wealth and being rich is better when it’s done together!

Related posts:

• How Much of Your Paycheck Should You Invest?
• How to Build Wealth with a Low Income
• 6 Reasons Most People Lose Money in Stocks