Once per week, I will browse the Personal Finance sub-Reddit for commonly asked questions that I think are relevant or interesting to the mission of MFB and post a response with my thoughts. This week’s Q&A is around choosing the “right” index fund for your first investment.

Which index fund to invest in?
by inpersonalfinance

Let’s hit a few key points up-front, many of which demonstrate that this poster is certainly on the right track:

1. Index Funds vs. Individual Stocks: Like I mentioned in this post, the reason we like to invest in Index Funds is diversification. Index funds essentially track the underlying performance of a “basket” of stocks, which provides significantly enhanced diversification vs. investing in an individual company. The underlying “basket” can vary greatly however. There are index funds tied to the S&P 500, specific industry sectors, specific geographies, specific company sizes, etc. Each of these can help accomplish a defined investment strategy goal, but our preference for first-timers is to choose a broad total stock market index
2. ETF vs. Mutual Fund: You can get exposure to an underlying index through either an ETF (Exchange Traded Fund) or a Mutual Fund. The briefest explanation of the difference is that ETFs trade like normal stocks (you can buy and sell at any point during the trading day that you want at the current price), whereas Mutual Funds can only can be purchased at the end of each trading day based on a calculated price. We personally prefer ETFs due to increased liquidity and price visibility. For a more detailed explanation, see this Investopedia page
3. ETF / Mutual Fund Providers: When the poster mentions “everyone agrees VOO through Vanguard is the best index … but I’ve also heard of S&P 500”, they are correct that it is essentially “the same thing”. In this example, the S&P 500 is the benchmark / index that is being tracked by the ETF VOO, which is managed and sold by Vanguard. Vanguard is a asset manager that “builds” and manages VOO in such a way that it will mirror the performance of the S&P 500 index, and in return charges a (very) small fee. Fortunately the rise of passive investing and competition for investors’ dollars has driven down fees meaningfully within this industry

OK – so now how do I choose the best index fund? For a first-time investor, we would recommend going with (i) an ETF, that (ii) tracks the broadest US-based stock market exposure, and (iii) contains very low fees. In order to accomplish this, we would suggest VTI, which is a total-U.S. stock market index ETF managed by Vanguard. While this is NOT investment advice, generally speaking we are big fans of Vanguard products given their very (competitive) low fees, huge asset base under management across their investment products, and lengthy track record of being the core pioneers of the passive investing movement.

Feel free to let us know what your favorite index funds are down in the comments below!