How To Buy Index Funds (2024)

You’ll need an investment account to buy index funds. Different kinds of investment accounts are best suited for different types of goals:

• Mid- and Long-Term Goals. Taxable investment accounts allow you to build wealth through investing but require you to pay taxes whenever you receive dividends or make a profit off of investment sales. Taxable accounts are helpful for those looking to reach large money goals before retirement or for those who have already maxed out their retirement accounts for the year.
• Retirement. Registered accounts, such as a Registered Retirement Savings Plan (RRSP) and Tax-Free Savings Account (TFSA), offer certain tax advantages to help you save for retirement. These accounts are built for long-term saving. An RRSP is tax-deferred, so you don’t have to pay tax on its earnings until you withdraw funds (and you must withdraw by the end of the year you turn 71). As for a TFSA, you never have to pay tax on your earnings whether contributing or withdrawing funds up to an annual contribution limit, which is indexed to inflation and rounded to the nearest $500.
• Educational Expenses. People looking to help their children with educational expenses should consider Registered Education Savings Plans (RESPs) for each of them. These accounts offer similar tax advantages as an RRSP or TFSA because the money in an RESP is also tax-sheltered while it grows inside the account. Though it is taxed as income when withdrawn into the hands of the student, many students do not have to pay income tax on it because they don’t make enough money to be taxed at all. The biggest benefit to an RESP are the savings grants offered by the government to a possible maximum of $3,500 each year depending on the amount contributed and the government-offered savings bond up to a maximum of $1,000 each year a contributor’s income falls below a certain threshold.
• Children. A child cannot legally open a brokerage account on their own in Canada. Instead, parents and guardians can set up an informal trust (ITF or “in-trust for” accounts). These are non-registered savings or investment accounts that are opened for the benefit of another person and are deemed informal because there’s usually no deed of trust in place. Contributors and trustees can put in as much as they want with no limits on how much they can contribute or what the money must be used for. ITFs also have tax benefits in that capital gains tax are taxed in the hands of the child (which means they’ll probably pay little to no tax) and the income generated by the ITF (interest or dividends) is taxed in the hands of the contributor or trustee.

If you choose an online brokerage account, you buy and sell your own investments, and fees tend to be minimal. If you choose a managed brokerage account with a human investment advisor, you’ll generally pay a percentage of assets each year to have someone manage your investments for you, such as 1% of the asset value.

You can also opt for a robo advisor account. Answer some questions about your risk tolerance, timeline and goals, and an algorithm recommends a portfolio mix for you. This is convenient, but you’ll pay higher fees than it would cost you on your own. For example Wealthsimple charges 0.50% of asset value, which drops down to 0.40% for accounts over $100,000, and Questrade charges 0.25% of asset value. which drops down to 0.20% for the same reason (this means a $10,000 account would be charged $50 by Wealthsimple and $25 by Questrade).

Your index fund investment strategy takes into account your overall financial goals, risk tolerance and timeline. If you’re working with a financial advisor, they’ll help you determine the best mix of funds for your situation. If you open an account with a robo-advisor, the algorithm will suggest a strategy based on your answers to questions when you open the account.

If you’re choosing an index fund allocation on your own, it may help to use an online tool to steer you in the right direction. For example, BMO InvestorLine offers a needs assessment questionnaire, which will help you build your investor profile, asking questions about risk tolerance, time horizon and financial goals, so they can recommend an appropriate and individualized asset mix and allocation.

In general, advisors recommend keeping more of your portfolio in stocks and less in fixed-income products like bonds when you’re further from a goal. As you get closer to the goal, gradually adjust the mix away from stock and into bonds.

How aggressive you are—reflected in the ratio of stock index funds to bond index funds—depends on how much risk you’re willing to take on. For shorter term goals less than three years away, you may be better off with high-yield savings accounts or certificates of deposit (CDs). For longer-term goals that are more than three to five years out, consider taking on more risk by investing in stock index funds.

It’s important to know what you’re getting in an index fund, so research is key.

First, pick an index—or more than one index. TheS&P 500is probably the most well-known index, but there are also indexes based on company size, business sector and market opportunity, such as emerging markets. Equity indexes are generally well suited to adding growth potential (and risk) to your portfolio, and the more niche your equity index, generally the more risk you’re taking on. Bond-based indexes add stability to investment portfolios and more modest returns.

Indexes to start your search with include:

• Broad market indexes like the Solactive Canada Broad Market Index, CIBC U.S. Broad Market Index Fund and the iShares Core S&P 500 Index ETF (Canadian-Hedged). Funds tracking Canadian and U.S. core indexes are commonly chosen by those looking to construct simpletwo- or three-fund portfolios.
• Equity indexes that group companies by size like the Morningstar Canada Domestic Index (large-cap companies), MSCI Canada Small-Cap Index (small-cap companies) and the S&P/TSX Completion Index (mid-cap companies). Generally, the smaller the companies in an index, the more risk and growth potential you take on.
• Indexes offering exposure to stocks from companies outside of Canada., like S&P 500 Index Funds. Usually, the less developed a country’s economy, the more risk and growth potential you take on.
• Indexes based in the bond and fixed income markets, such as the FTSE Canada Universe Bond Index. Indexes with corporate bonds typically offer higher returns (and more risk) than those that only invest in government bonds.

Once you’ve settled on an index or indexes, you’re ready to research individual funds. When you’re comparing index funds, here are some things to consider:

1. Expense Ratio.This is the cost to administer the fund each year. All things being equal, index funds based on the same index all track the same thing, so expense ratio can be a big deciding factor. If one fund charged 0.19% and another charged 0.03%, you’d save $16 a year per $10,000 you invested by going with the lower cost fund.
2. Other Fees.You can generally avoid trading fees on index funds at most major brokerages, but be sure to look out for loads, or special fees charged by certain mutual funds when you buy or sell them. You should be able to find index funds for any index without load fees at most major brokerages, so don’t opt for a fund with loads just because it’s the first you’ve found.
3. Investment Minimums.If you don’t have the cash to meet the minimum investment required, you can cross that fund off your list. If you really want to buy into that particular index, you should look for theexchange-traded fund(ETF) version of that fund, which will typically have no minimum beyond the price of one share.

Keep in mind that index funds tracking the same index at different companies will have virtually identical holdings, so expenses should be your primary focus. You’ll want to pay attention to expense ratios, trading fees and loads. You’ll probably want to choose the index funds offered in-house by your brokerage of choice to minimize fees.

Once you have a brokerage account, you can buy shares of the index funds you’ve settled on. Generally, you’ll search for or type in the ticker symbol of the fund you want to purchase and the dollar amount you want to invest.

You’ll need to buy enough to reach the fund’s investment minimum. Two investment platforms in Canada, Interactive Brokers and Wealthsimple, offer fractional shares, but they aren’t as common an option in Canada as they are in the U.S. The site may ask for your preference regardingdividends—whether they should be used to purchase additional fund shares or deposited into your account as cash. If you’re reinvesting for the long term, most experts recommend youreinvest your dividendsbecause historically dividends have been responsible for substantial investment growth.

Investing is typically an ongoing practice, so you’ll need to think about your plan for buying index funds over time. Financial advisors often recommenddollar-cost averaging—the practice of putting a certain amount of money into your investments at set intervals.

“The beauty of dollar cost averaging is that investors add to their portfolio in high and low markets, eliminating the emotional push to buy high and sell low,” says Erika Safran, a CFP in New York City.

To make this happen, set up automatic investments that happen on a schedule (such as once a month or every payday) with your brokerage. This ensures that you’ll continue to invest on a regular schedule.

In general, investing is about the long game: Although the stock market has its short-term ups and downs, over your investing life, buying and holding a diverse investment mix historically results in successful returns.

For best results, review your portfolio every six to 12 months andrebalance when your investmentshave drifted too far from your original allocation. To rebalance, you’ll sell some of the categories that have gotten too large and buy more of the category that’s gotten too small. This helps keep your portfolio on track to reach your goals.

Although buying and holding is a solid investment strategy, you should also think about when and how you’ll sell your shares. If you’re investing in a taxable account, you’ll have to consider capital gains taxes and whether you can offset gains with losses in other investments through a process called tax-loss harvesting. If you’re in a tax-advantaged retirement account, you’ll want to brainstorm ways to minimize the taxable income you earn each year through retirement account withdrawals. A financial advisor or tax professional can help you figure out the best strategies for managing withdrawals from any type of investment account.