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I started investing in 401K pretty late (around 28) at my previous employer. That account has about $1,500 in it. I want to take it out of there and use it to invest in Vanguard funds. I already have an account at Vanguard where I have put in some starting money for an index fund.

Would it be wise to use that 401K to put into that index fund? I'm probably going to incur fees and penalties on it. I'm not sure how much. But seeing that the amount is relatively small I feel like putting it somewhere I can experiment with it.

If cashing out is a bad option then what would you suggest as a better option?

Any suggestions are welcome.

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I would create a "Rollover IRA". These IRAs are designed to take funds from a 401k and allow you to invest them without incurring a cash out penalty nor a tax due. You will have more choices than if you leave it at your old 401k.

If you cash out the 401k, you'll have much less to invest ($1500 - penalty - taxes) vs. doing a rollover 401k where you'll still have $1500 to invest.

Then, once the money is inside the new Rollover IRA you can invest in whatever you please.

If you want to invest in Vanguard funds, I recommend opening the Rollover IRA at Vanguard. Here is Vanguard's information page about rollovers from 401ks: https://investor.vanguard.com/what-we-offer/401k-rollovers/401k-403b-to-ira-rollover-benefits

When you next change jobs and have another 401k with funds in it, you can roll it into the same Rollover IRA.

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    Great advice from @AlexB. I've followed that approach through quite a few job transitions. Vanguard's S&P 500 Index Fund has a super-low expense ratio (0.17%). Their extended market ETF has an even lower one.
    – Scott Lawrence
    Commented Mar 5, 2014 at 17:23
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    I just "rolled over" my old 401K to Vanguard. :) Thanks for the advice. As a side note, I have some money invested in VFINX.
    – Gabbar
    Commented Mar 5, 2014 at 18:49

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