How to build a portfolio with index funds

Why index fund/ETF?

For the average Joe, the easiest and safest way to get good returns on their savings. Buying an index fund that tracks the S&P 500 for instance would have given you 10-11% average returns from 1926-2018. Let that sink in for a minute. Not only does it give you the diversification you need, but index funds are very cost-effective too. I own IUSA myself, and the costs per year are as low as 0.07%. The biggest risk for you when investing in funds is the cost per year because that is something you cannot change and it is there no matter what. To minimize the costs and you will be good. 

Can you build a portfolio of index funds?

The short answer is yes. If you have the funds to do so and you want to hit all parts of the world, instead of just buying an index fund that tracks the 500 biggest companies in the US, you can allocate your funds in several index funds. I for instance went with a 60% in a global index fund, 20% to track Europe in general, 10% to track the Nordic countries & 5% split in emerging markets and Norway. The last 5% in Norway is because I am Norwegian and I believe the market and economy are strong in Norway. This is just an example however on how you can build your own portfolio of index funds that track different indexes and markets around the world.

I bet I need a lot to start investing in index funds

The great thing about most brokers and stocks/index funds is that you can buy fractional shares. So you can invest as little as $1/month, however, in Norway, we need approximately $10 to buy most index funds. Even that is a very low investment and most people can afford that each month. My tip is to always try saving some money in index funds each month. That way you will end up getting some nice retirement money and can actually enjoy being retired.

Key facts about index funds

Cost beneficial

Like I mentioned above, index funds are very cost beneficial. They cost you as little as 0.03% a year, in this case, that is the ETF VTI from Vanguard. Costs are important to make as low as possible since the fee is gonna be the biggest risk overtime for you and your returns. Over a 40 year period, there is gonna be a huge difference between 0.03% in fees and 0.04% fees, and therefore you want to minimize it to get the most out of your returns and keep as much as you can for yourself.

Requires little to start and is easy

It requires very little to start investing/saving in an index fund or ETF. As mentioned above, with most brokers you can purchase fractional shares, which again can let you start investing/saving with as little as $1. This makes it easier for you to save money and invest every month when you know you can invest that little at a time.

Re-acurring saving every month

One of the best things about index funds & ETFs, is that you can have a re-acurring transactions every single month. Which means you start a plan on how much you want to save each month, and then the money just goes automatically from your wallet and into the index fund you have chosen. 

The benefits with this, is that you easily forget that you are saving, which again will make it more difficult for you take those savings out and use them on something else. Another thing that is beneficial with this, is that you can put in money in your index fund and buy at different prices. Hitting it at different prices will at the end give you a better average cost. 

But the stock market is insecure

Yes, the stock market will take you on a rollercoaster ride from time to time. You will face financial crises, recessions, pandemics (like Covid-19), and maybe some other insecurities like world wars. But, even with these events happening, the market has always gone up afterward no matter what. Let us take 1926-2020, in that time period, the world faced one world war, a cold war, several financial crises, and several pandemics, and still, the average return in that period is 8-9% a year. So in the short term, the stock market can be insecure and you can make some losses, but in the long run, there is no better place to have your savings.

How do I build my portfolio?

Building up an index fund portfolio can vary a lot. You can go with the easy approach and gather a global index fund, European index fund, emerging markets index fund, etc. Or you can even be more specific and go with the sectors you think will do better in the upcoming years. Maybe a technology index fund/ETF? Or maybe you want to go for small-cap companies, what better way than to get an index fund/ETF that tracks the small-cap index? The point is, there are multiple options out there for every kind of investor/saver. It is up to you how you want to diversify your portfolio, but keep in mind, my tip to you is to allocate your funds towards all the markets/countries in the world. That way you can get the most out of everything. And maybe then start adding sector-specific index funds or ETF.

What is an index?

A stock index, or stock market index, is an index that measures a stock market, or a subset of the stock market, that helps investors compare current price levels with past prices to calculate market performance. It is computed from the prices of selected stocks (typically a weighted arithmetic mean).

Two of the primary criteria of an index are that it is investable and transparent: The method of its construction are specified. Investors can invest in a stock market index by buying an index fund, which are structured as either a mutual fund or an exchange-traded fund, and «track» an index. The difference between an index fund’s performance and the index, if any, is called tracking error. For a list of major stock market indices, see List of stock market indices.

What is an index fund/ETF?

Exchange traded fund (or ETF if you like) is an index fund that is traded on the stock exchange like a regular company. The reason why I like an ETF even more, is because of how easy you can get your money out if you need them fast. Reason two is that an ETF is usually more cost beneficial than index funds, and that is pretty crazy to think about, since index funds are already pretty cheap.

An index fund (also index tracker) is a mutual fund or exchange-traded fund (ETF) designed to follow certain preset rules so that the fund can track a specified basket of underlying investments. Those rules may include tracking prominent indexes like the S&P 500 or the Dow Jones Industrial Average. Index funds may also have rules that screen for social and sustainable criteria. 

So to summarize, an index fund is a fund that is made of many different companies that follow the respective index that the fund wants to track or beat. So if the fund is tracking the S&P 500, then the index fund will be made of all those companies that is a part of the S&P 500 index. And if the index fund wants to track the small cap index, then the fund would be made out of all the companies that goes under those criterias for that index. 

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