How to Choose an Index Fund | Which Index to Invest In

I’ve had a couple people recently tell me that they know they want to invest via an index fund, but they don’t know how to choose which one to invest in. Really, there’s two separate questions to answer:

1. Which index do you want your fund to track?
2. Which of the funds that track that index do you want to invest in?

Which index to track?

There are really too many indexes to list in one place. Generally, the best approach is to figure out what allocation you want (“U.S. vs. International” and “developed markets vs emerging markets”), then find an index–or combination of indexes–that will allow you to meet that allocation. Here are a few of the most common indexes to get you started:

S&P 500: Without a doubt, the most frequently tracked index. It includes 500 of the biggest (Note: not the 500 biggest) companies in the U.S. as measured by market capitalization.

Wilshire 5000: The second most commonly tracked index. It includes every publicly-owned U.S. stock for which there is readily-available price data. (Note: It originally included 5,000 companies, but now it includes far more.) If you want to own the entire U.S. stock market, this is the way to do it.

Wilshire 4500: The Wilshire 5000 after subtracting all the companies included in the S&P 500. If you already own an S&P 500 index fund, this index can be useful for adding some exposure to small and mid-cap companies.

FTSE All-World Index: Tracks 2,700 stocks both in the U.S. and abroad (including both well-established and developing markets).

FTSE All-World ex US Index: Tracks a broad range of non-U.S. stocks in both developing and well-established markets.

Which fund to use?

Once you’ve chosen which index you want your fund to track, you still need to choose which fund to invest in, as there are numerous funds that track most of the indexes mentioned above. As you’d expect, this decision comes down to a few simple considerations:

Expense ratio of the fund: In terms of return provided by the fund, this is without a doubt the single most important factor.

Minimum investment: Of course, if the amount you have available to invest doesn’t meet the minimum investment requirement for a given fund, you’ll need to find a different one. (For example, most Vanguard index funds have a $3,000 minimum investment.)

Customer Service/Quality of Online Interface: If you’re going to be giving a company your business, things like this matter. Unfortunately, this is difficult to evaluate until you’re already a customer. My only suggestion here: Ask around.