Reader Question: How To Pick An Index Fund With A Low Initial Investment

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Recently, I received an email from a reader of The Frugal Law Student asking a common yet important question for young people just getting started in investing:

I just finished my Masters, and talked my parents into contributing to some sort of mutual fund or index fund, etc. instead of giving me a ridiculous piece of jewelry that I’d never wear (how I wish they’d help me pay down the debt instead! alas!) Do you have any suggestions as to how I should go about picking one that has a low minimum buy-in? I know the very basics but nothing about where to get started.

Great question! This is something that I have struggled with as well.

I think index funds are great, especially for people just getting started with investing. I’ve written about them before, so I won’t bore you here with the benefits of index funds.

What holds many young investors back from investing in index funds are the high initial investment required to start the investment. For example, Trent at The Simple Dollar, is a big believer in Vanguard Index funds, and with good reason. They have solid customer service and a great track record to boot. However, in order to buy most Vanguard funds, the minimum investment is $3,000!

After doing some research, it looks like most index funds require a large amount of up front investment. The range was between $2,5000 -$3,000. If you don’t have this kind of cash on hand, your best option is to save for it. This is what Trent does. He’ll set aside money each month into a savings account. As soon as he has the minimum initial investment, he’ll buy the fund. After you buy the fund, the minimum monthly investment is usually pretty reasonable.

If you don’t want wait to around until you have the money to invest, you can always try actively managed mutual funds. There are hundreds of mutual funds and many have initial investments as low as $250. The drawback on actively managed funds is expense costs are higher than index funds. Also, unlike index funds which generally keep up with the overall market, actively managed funds can tank and not come anywhere near the market average.

How to Screen Mutual Funds

Morningstar is a reliable independent investment research firm, so we’ll use them.

• Open up Moringstar’s Fund Selector. You’ll now see an app with a bunch of different drop down menus. Since we’re focusing on low cost investments, we’ll filter the funds accordingly.
• Under “Fund Type”, we’ll select balanced. Since this is a first time investor, we’ll keep things simple.
• Moving on to Cost and Purchase, we’ll set the minimum initial investment for less than or equal to $500. We also need to choose whether to have a load or no load fund. A load fund means that there’s a sale charge when you buy shares in the fund, no load means there’s no charge. We’ll select no load to keep costs down. We’ll select the lowest expense ratio at .5%.
• Finally, we’ll pick the risk. This is the famous Morningstar Rating you hear investors talk about. We’ll set it for 4 and 5 stars.
• I didn’t mess with any of the return filters. I wanted to see the results for the 1 yr, 3yr, 5yr, and 10yr returns.
• Hit show results.

Fascinating. Many of the suggested funds are held by American Funds, the company that I do investing with. They all look to be solid investments. You can click on each one to get a detailed description of the fund. Most just require $250 to start an investment.

Once you select the fund you want to invest in, you can go to that fund’s website and open up an account with them. American Funds is super easy to start an account with. Additionally, they have a great online account management service that makes buying, selling, or starting automatic investment plans easy.

What do you all think? Did I miss anything? Don’t agree with me? Have any better ideas? Drop a comment in the comment box and add to the conversation!

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9 Comments

1. Fromwe.Com » Reader Question: How To Pick An Index Fund With A Low Initial … on 01.10.2007 at 15:52

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2. Romtej.Com » Reader Question: How To Pick An Index Fund With A Low Initial … on 01.10.2007 at 16:18

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3. Andrew Flusche on 01.10.2007 at 17:45 (Reply)

   Timely advice! We just selected the first investments for our 403(b) plan. Honestly, I kind-of shot in the dark. I think I’ll see what happens in the next few months and try to figure out why I lost my money.

   By the way, nice holiday header!!

4. Carnival of Personal Finance #121 - Columbus Day Edition (Ask Mr Credit Card’s Blog) on 08.10.2007 at 02:30

   […] As far as investments goes, I have a money market account. Stop asking yourself do I need an emergency fund? Off course you do. You should start saving and let money build right away. I would not even waste my time day trading or any of that as I think that trading is for losers. Instead, I would learn how to pick an index fund with low initial investment. […]

5. rocket finance » Blog Archive » Carnival of Personal Finance #121 on 08.10.2007 at 08:49

   […] am going to spend more time reading this post: “How to Pick a Mutual Fund With a Low Initial Investmet”. I want to invest with Vanguard, but there is no way that I can come up with the minimum initial […]

6. Raymond on 08.10.2007 at 21:13 (Reply)

   I like all of the Fidelity funds..I’m personally heavily invested in the Fidelity Asian emerging market funds. It’s a great way to take advantage of rapid growth areas but maintain a basic level of stability compared to dabbling in individual stocks.

7. David on 10.10.2007 at 13:38 (Reply)

   American funds are actively managed and front loaded so you’re a little off with your advocacy for index investing if you do business with this firm, which is excellent (agree with you there).

8. Neil P. on 17.10.2007 at 20:32 (Reply)

   Interesting post on investing. I’d suggest that index-based ETFs (Exchange Traded Funds) would be a good option. They track market indexes just like index funds, and are sometimes more tax-efficient. They also have no minimums but you do need to open a brokerage account. It is very straightforward to have a diversified portfolio using ETFs, as there are so many of them specialized for different markets. The ones I like (obviously, please do your own research into the merits of each based on your preferences) are ILF (Latin America Emerging Markets), INP (India Emerging Markets), IGE (Global Energy/Oil), EFV (non-USA developed markets value), DBN (international basic materials), DBR (international healthcare), and IXN (Global technology). VGPMX (Precious metals) and EGLRX (overseas real-estate) are specialized mutual funds that also seems good.

   Bottom line, invest in what you believe will do well over the long haul- everyone needs healthcare, everyone needs energy, etc. By also investing overseas, you get the advantage of appreciation due to dollar decline (in addition to the growth of the European or other stock). However, one needs to balance this against the risk of more volatility in overseas investments (and the possibility of the dollar gaining in future).

   Neil.

9. Chuck Clark on 02.01.2008 at 17:38 (Reply)

   If you’re looking for low intial investments, many fund families will allow you to start off with a much lower amount $100-$250 if you set up an automatic investment plan. Monthly automatic investments can be as low as $25-$50.

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