FIRE Pillar 9: Low-cost Index Fund Investing
Investing your money wisely is a crucial element of the FIRE methodology. Low-cost index funds are often seen as a safer option for novice stock market investors, as there is less risk of selecting a stock that does not perform well impacting the overall performance of the fund.
What is a low-cost index fund?
Before putting your money into any kind of investment, it is important to understand exactly where your cash is going and how your chosen investment is going to work.
An index fund is a type of investment vehicle whose purpose is to mirror or track the performance of a specific index.
Some of the most well-known indices in the United Kingdom are the FTSE 100, the FTSE 250 and the FTSE All-share.
Index funds are passively managed. In essence, this means that they are made up of a group of stocks that rarely changes (sometimes it won’t ever change). This is very different to an actively managed fund, where individual stocks would be regularly evaluated to be bought & sold by portfolio managers.
For example, if you decided to invest in a FTSE 250 index fund, it would track the top 250 London Stock Exchange (LSE) stocks.
Why invest in low-cost index funds?
Index funds are often popular with newcomers investing in stocks. Because there are many different companies in each of the big indices, it is not necessary to have prior experience of how to assess the pros and cons of investing in different businesses. As The Balance puts it, “company-specific risk is diversified away”.
As an index fund is passive (i.e. not managed), the expenses that go hand in hand with actively managed funds (to pay portfolio managers etc,) do not apply. This means that index funds are relatively cheap in comparison.
On the other hand, lower risks, often mean smaller returns.
Also, if the stock market is not doing so well, you could lose money.
While the level of risk associated with index funds is generally seen as relatively low, some believe that index funds are not low risk, at all. This is a reminder that no investment is a “sure thing” and it’s very important to do your research before putting your money into any type of investment.
It’s also worth bearing in mind that because an index fund is designed to track a specific index (so the FTSE 100 tracks the top 100 LSE stocks), you may end up with exposure to businesses you would not like to invest in, such as arms manufacturers or oil companies.
How to buy low-cost index funds?
One of the first things you will need to do to before you invest in an index fund is to find a broker.
It is worth noting at this point that in order to invest in an index fund, you will normally require a lump sum of money. The minimum amount you can invest will depend on which broker you settle on.
Broker fees vary, so always check in advance how much you will be expected to pay. Some brokers advertise introductory offers. You should also consider how easy a broker account is to use, before signing up.
As always, do your research to find a broker you are comfortable working with. If you are unsure about anything, try and get a second opinion from somebody you trust, ideally somebody with relative experience.
Once you have completed your research, it is time to make a decision about which index you want to track. As well as the two FTSE indices we mentioned above, you could go for the FTSE USA Index, for example, or any of a large number of indices worldwide. There is a lot of choice, as almost every index has an index fund.
Most importantly, make sure that you choose an index fund and broker to suit what you have to spend.
Investing your money always carries an element of risk. It’s crucial to understand exactly where your money is going and how it will be invested.
Index funds are often popular with novice investors as they are relatively inexpensive and arguably come with a lower risk than other types of investment. They also require less active management as they are more protected against volatility that can occur with specific stocks.
The FIRE Movement involves saving and investing your money, so you can retire early. Index funds could help you to get your money working for you.