How do I Choose the Best Total Stock Market Index Fund?

A highly advocated investment for all investors is a total stock market index fund. These funds are essentially mutual funds that replicate a market index, therefore guaranteeing near-market returns and reduced risk. Investors can choose from several total stock market index funds that replicate indices from around the world. Before investing, investors will want to consider several factors in evaluating index fund performance. The funds vary in rate of return, strategy, fees, number of holdings, and initial investment.

Oftentimes the management fees are what set total stock market index funds apart from mutual funds. Like a regular mutual fund, a total stock market index fund incurs both transaction and maintenance fees. The fees are generally lower because the fund composition is based on the entire market composition, significantly reducing the research and time required to select stocks and operate the fund. The critical fee differentiating total stock market index funds is the transaction fee, which is directly related to how often the index trades stocks.

Available funds vary in the number of company stocks they hold. The name of the fund will often indicate the number of holdings, such as the Russell 3000, but other funds — such as the Wilshire 5000 — contain more than the name suggests. An index fund that rigidly maintains a specific number of company holdings trades stocks more often than funds that fluctuate. Trading stocks is referred to as the turnover rate, and index funds with a higher turnover rate will charge higher management fees. Investors should consider a fund’s turnover rate when deciding whether to invest.

Another consideration investors must be aware of is the initial investment. Depending on how the investor purchases a security, he may be required to make a minimum investment. If a person invests directly through a mutual fund company, he may be required to invest from $3,000 to $10,000 US Dollars (USD). If the investor purchases a fund traded on the stock market as an electronic transfer fund (ETF), then he will be able to invest any amount he wishes.

Another critical component of index fund performance is how much taxes are incurred. How often a fund trades shares and how investors invest in the fund influence the tax burden. Investors are also taxed on dividends received, though this value will not vary significantly among index funds.

An investor will want to consider how well a fund fits within his portfolio strategy. Investors should aim to have a diversified portfolio, because it reduces risk. A total stock market index fund replicates a marketwide index, thus reducing the portfolio risk. Funds vary in how they allocate assets to small, mid- and large-cap stocks and, accordingly, the risk and returns differ slightly. The fund performance and strategy should be in accordance with an investor’s goals.

An investor may want to seriously consider allocating a part of his investment assets to a total stock market index fund. By definition, the fund is designed to replicate market performance. Mutual funds normally return less than the market after management fees are deducted. This emphasizes the fact that selecting good stocks is not well understood. Thus, by investing in a total stock market index fund, investors reduce the risk of investing in poor stocks and consistently receive close to the overall market return.