How Can an Investor Get Into Index Funds?

To those who have opened a self-directed brokerage account and have bought and sold stocks, this might seem like a trivial question. However, this whole business can be quite bewildering to the uninitiated. To start with, you need to choose a broker. I won’t recommend any particular broker, but the following surveys may help.

U.S. Brokers. In a survey by SmartMoney, the top brokers in the premium category were E*Trade, Fidelity, and Charles Schwab. The top brokers in the discount category were TradeKing, Scottrade, and Firstrade.

Canadian Brokers. In a survey by the Globe and Mail, the top Canadian online brokers were Qtrade Investor, E*Trade Canada, TD Waterhouse, and BMO Investorline.

Opening an account. After choosing a broker, follow the instructions on the broker’s web site for opening an account. This process is similar to opening a regular bank account except that the brokerage account can hold stocks, bonds, and mutual funds in addition to cash. There are several types of brokerage accounts, and the main choice is whether or not the account is tax-sheltered for retirement (IRA in the U.S. and RRSP in Canada). For non-retirement accounts, you can choose a cash account or a margin account. The difference here is that margin accounts permit the risky practice of borrowing money to invest.

Buying the index fund units. Once the account is open and full of cash, you need to decide what fraction of your portfolio that you want in index funds, bonds, and possibly other investments. For the index fund portion, choose one or more of the many available index funds. Two that I discussed in my last post were Vanguard Total Stock Market (U.S., ticker VTI) and iShares Canadian Large Cap 60 Index (Canada, ticker XIU). When placing buy or sell orders, the ticker symbol is used to identify what you are trading. I chose these two funds as examples because they are large, popular, and have low fees; I have no financial interest in these fund companies.

For the average person, an advantage of indexing is that there is no need to follow individual stocks. You are betting on the continued success of the companies making up the index, which is an entire country in the case of the two example index funds discussed above.

In the next post, I will discuss some of the potential pitfalls of going it alone that must be avoided to be a successful investor.