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Personal Finance

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

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!