How do you evaluate index funds?
Part 2 on picking a portfolio begins! Although you might have been hoping I would just list solid index fund choices on this post, I don’t think that is helpful for different reasons. The primary reason is you may just listen to me, buy it, and hope for the best without knowing exactly what you’re buying. So, in this post, I want to talk the first things to consider prior to buying an index fund.
1. Trading costs/commission free options – at the very beginning, you need to know how much it costs to make a trade. TD Ameritrade, Vanguard, and Charles Schwab offer commission free trading now. This makes a difference if you’re planning to dollar cost average / trade regularly over time. If each time you trade it costs you $7, and you aren’t trading with a large amount of money (aka residents), then its costing you too much.
2. Expense ratio – how much do you pay each year to be involved in the ETF. There are a multitude of ETFs that track the same index. For example, for VTI – Vanguard Total Stock Market ETF – which tracks the total stark market, the expense ratio is 0.03%. So, for $100 invested each year, it costs you 3 cents. This is why index funds are awesome! The overall expense ratio is less than mutual funds or a financial advisor.
3. Decide what index you want to track – there are SO many options for index funds and deciding what index/sector etc you want to track is another decision you have to make. Most commonly, the decision will be do you want to follow the S&P 500 (essentially 500 large companies) vs the total stock market index (all stocks including small, medium, and large companies). You can break this down further and buy indexes of small/mid/large cap companies, health care, communications, real estate sector etc.
If you are super eager to buy something now, I would make the decision between you wanting to buy the S&P 500 (VOO) or the total stock market etf (VTI). BUT, I’m realizing this is going to take a few more posts to explain. Next post is on definitions/how to evaluate the stocks that comprises an ETF.
Couple of Surgeons 