Index Funds: The ETF Alternative

I already pointed out that dollar-cost averaging is very expensive with ETFs, but don't worry, there's a great alternative that will still allow you to follow the exact same strategy. The alternative is Index Funds. Dollar-cost averagers can mix a few Index Funds into their ETF portfolio so that they can make small and frequent contributions to their portfolio without losing a lot of money in transaction fees. Even if you're trading through an online brokerage rather than dealing directly with a fund family, most Index Funds will still allow you to contribute money as often as you like without ever charging a fee.

A word of caution. When you begin comparing them to ETFs, you'll notice that Index Funds have higher expense ratios. Traditional funds and Index funds have to negotiate with online brokerage houses to get listed in investment databases. Rather than paying these fees, they pass the expense on to investors which increases the expense ratio of the fund. Typically, Index funds add between 0.15% and 0.35% to their expense ratio as a result of this expense. ETFs are treated differently than index funds, they aren't charged anything since they trade on the exchange like any other stock. These factors make it very hard for Index Funds to have expense ratios as low as ETFs.

This doesn't mean that all Index Funds have higher expense ratios, just that they tend to, unless they are very large. The point is, stick to the largest index funds that track the broadest indexes to minimize your expenses. An example of a great Index Fund that can compete with any ETF is Vanguard's S&P 500 fund (VFINX) with an expense ratio of 0.15%. Not many ETFs can top that, and they can't even come close if you factor in what a dollar-cost averager would pay in transaction fees when contributing frequently to an ETF.

Conclusion: So what are you waiting for?

ETF Investing is already getting big and the popularity will continue to grow because there is so much working in this strategy's favor. This is the most cost efficient and tax efficient strategy available, it's hard for other strategies to measure up, especially if you're investing in a taxable account. ETF Investing is also much easier to learn than many other strategies so it's perfect for beginners or anyone that doesn't want to spend hours per week researching investments and the market.

So what type of person masters this strategy quickly? Oddly, a person who places great value on their personal time, someone who doesn't want to become a professional investor or spend a lot of time managing their portfolio or studying stocks or the stock market. Who will have trouble mastering this strategy? If you're the type that can't resist trading frequently, trying to time the market, or chasing the "hot" sectors of the market, this strategy isn't for you, successful ETF Investors are Buy-and-Holders.

Her's a final encouraging word for the next time the market tests your resolve. Don't expect your ETF portfolio to always go up and always beat every broad index all the time. Sometimes the market will pop when conditions are extremely bullish and this can make it feel like your portfolio is lagging. Don't worry, you will shine during bearish, choppy, and volatile markets, your well planned blend of different assets across many categories maximizes returns while minimizing potential losses so you will ALWAYS win out in the long-term. Find high quality ETFs and a few Index Funds, follow the asset allocation and diversification guidelines you just learned, and then BUY AND HOLD AND HOLD AND HOLD.