An Easy Place to Start Investing in Shares

One of the easiest options when starting out in share investing is investing in an index fund.

An index fund is a managed fund that aims to replicate the movement of a specific index. For example, the S&P/ASX 200 is an index that represents the top 200 companies listed on the Australian Share market by market capitalisation. The rise and fall of this index reflects the movements of the top 200 companies. An index fund based on the S&P/ASX 200 holds shares in the top 200 Australian companies and will follow the trend of this index and match its total return.

Features of an Index Fund

• Investing in an index fund gives you exposure to a high range of companies. If your fund tracks the S&P/ASX 300 then you are investing in all of the top 300 Australian Companies. This is instant diversification.
• An index fund is an easy, hands off option. You don’t need to choose the best fund manager, worry about analysing share indicators, selecting the best shares or tracking the market.
• Investing in an index fund is best suited for long term investment strategies, 7 years or more.
• Index funds generally have lower fees than other managed funds. In Australia most active retail managed funds have fees around 2%. Index funds have fees below 1%.
• Index funds can be tax effective. Franking credits on dividends reduce your taxable income. Also active managed funds continuously buy and sell shares improve investment growth, and you have to pay capital gains tax every year on this activity even if you don’t withdraw any money. This can be a bit of a shock at tax time. Index funds buy and hold shares. They have much less activity and therefore you pay less capital gains tax every year.
• While active managed funds try to beat the index, an index fund will track it. This makes an index fund less volatile. While it won’t earn much more than the index, it won’t earn much less either. In an index fund, you’re not going to “beat the market” so for any given year, other funds may outperform an index fund. However, it is rare that an active managed fund will consistently outperform the index.
• The short term risk is the same as any other investment. The last year has definitely demonstrated that.

In the 1996 Berkshire Hathaway Annual Report, Warren Buffett wrote:

“Most investors, both institutional and individual, will find that the best way to own common stocks [shares] is through an index fund that charges minimal fees. Those following this path are sure to beat the net results of the great majority of investment professionals.”

Things to Consider

• There are a few options if you are looking to invest in an index fund, but the two main alternatives in Australia at the time of writing are the unlisted Vanguard Index Australian Shares Fund, which follows the S&P/ASX 300 index, and the listed SPDR S&P/ASX 200 exchange traded fund. The main difference for the investor is in the fee structure. The fees for the SPDR are generally lower, but they charge brokerage fees. If you want to dollar cost average (invest small amounts every month) then the brokerage fees will add significantly to the fees you pay. Vanguard doesn’t charge entry and exit fees making a better option for dollar cost averaging, and they offer a wider range of funds to choose from.
• Many financial advisors don’t recommend index funds because they tend not to get commissions. If you decide to invest in an index fund, it may be advantageous organising it yourself rather than go through an advisor. It’s a matter of filling out a few forms, so you can save yourself the extra fees by doing it yourself.
• Many investors choose to use an index fund as their core investment and add specialist funds or direct share share holdings in specific companies to their portfolio to enhance market return.

Note: This information is general in nature and not tailored to your situation. It is not financial advice. Your personal situation will dictate whether and what investment is right for you. You should consult a qualified expert and read and consider the Product Disclosure Statement of any investment fund before deciding whether to invest.

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