If you’re looking for a stress-free way to invest your money, index funds are a great option.
To find out more about this low-risk investment vehicle, take a look at the article below as we cover everything you need to know from how these mutual funds work to how to buy index funds in Australia.
What is an index fund?
Before you ask yourself ‘why invest in an index fund’, it’s important to understand what index funds are and how they work.
Index funds are mutual funds that allow you to invest in a collection of stocks and bonds as a single investment.
Unlike actively-managed funds which try to beat the market, an indexed fund in Australia lets you earn passive income by tracking the performance of a financial index (like the S&P/ASX 200).
Index funds are often used as a low-cost way of getting exposure to a wide range of assets. With these funds you can invest in stocks and shares, as well as other assets, like cash or gold, so you can diversify your portfolio very easily.
Australian index funds typically have lower fees than actively managed funds, and they can be a good option for investors who are looking for long-term growth.
For more information on how to invest in gold, take a look at this guide.
How Do Index Funds Work?
When buying an index fund, you are investing in all or most of the securities in a particular market index.
For instance, when you invest in Vanguard’s Australian Shares Index Fund which tracks the ASX300 index (a collection of the biggest 300 companies in Australia), you are either investing all the securities in the ASX300 index or you are buying a sample of securities that are most representative of that index.
When a company leaves an index, the fund manager will sell those shares and replace them with new ones, making index funds a safer option than directly buying stocks in a company.
How Do I Start Buying Index Funds?
There are a few ways you can invest in an index fund, each with its own advantages and disadvantages.
Here is a quick look at some of them:
1. Managed Fund
Managed funds are a type of investment vehicle where you pool your money along with other investors. The fund is overseen by a manager who charges a small fee, typically as a percentage of the money you have invested.
Who are they for: People who can invest higher amounts.
2. Exchange-traded fund (ETF)
An ETF is a bundle of securities listed on the stock market. They are becoming increasingly popular among Aussie investors who are using ETFs to track indices instead of the traditional managed fund – instead of buying US shares via online brokers, you can invest in ETFs that track the US market on ASX.
Although they work in the same way, there are some key differences between a managed fund and an ETF:
- ETFs are traded like stocks on the market, with the price changing throughout the day. Index funds are bought at the start of trading day.
- ETFs are listed on the stock exchange, whereas index funds are unlisted managed funds.
- ETFs are available for less than $100. Index funds, on the other hand, would require you to invest at least $5,000.
- ETFs have lower fees, but index funds have no transaction fee. When you buy and sell shares in an ETF, you will have to pay a ‘brokerage’ fee.
Who are they for: People with lower amounts to invest.
3. Investment platform
You could also try investing in index funds in Australia directly through an investment platform. The platform will let you buy into different managed funds and provide you with consolidated reports, so you can keep track of your investment.
Investment platform fees are not expensive, but you might be charged an administrative fee that you won’t get with traditional managed funds or an ETF.
Who are they for: People who want to manage their own investment.
How to Invest in Index Funds in Australia?
Here are a few things to consider before you invest in Australian index funds.
1. Develop a strategy
The most important thing is to consider what are your short and long-term goals with the investment?
Are you looking to withdraw funds in a year or are you willing to let it sit for seven to 10 years? Will you use the investment to supplement your income before retiring or cashing out to buy a car or a house? How much risk are you ready to take?
Considering these questions before investing in an index fund is a crucial part of the process as these answers will not only show you the best way to invest but will also help you calculate additional fees and costs.
2. Find the right fund for you
Compare several funds to find one that suits your needs and investment style.
It might be a good idea to talk to a financial advisor who will help you choose the best option for you.
Once you’ve done that, sign up with a fund manager or online broker to access the fund of your choice.
Bear in mind that ETFs are most accessible through online trading platforms where you can purchase them just like any other share or stock.
Pros and Cons of Investing in Index Funds in Australia
There are several reasons why investing in index funds can be a smart move.
So, what are some of the benefits?
Index funds tend to be less risky than individual stocks.
When you invest in an indexed fund in Australia, you’re diversified across different stocks and assets. Even if one stock in the index goes down, the other stocks will likely offset any losses.
They tend to outperform actively managed funds in the long run.
Actively-managed funds can be more profitable as they try to beat the market. Index funds, on the other hand, simply track the index and can thus provide steady income.
Index funds are a great choice for “hands-off” investing.
For those who do not want to actively monitor the stock market, but have a more “hands-off” approach, index funds are an excellent option. They are also a great way to earn a passive income.
Index funds usually have much lower fees than actively managed funds.
Since index funds are passively managed, you will pay less in brokerage and administrative fees. Plus, managed funds carry no transaction fees, letting you put more of your money into investments.
While investing in index funds in Australia is often praised for low costs, there are a few potential risks and disadvantages investors should be aware of.
An index fund may not perform as well as other types of mutual funds in certain market conditions.
With an index fund, you are tracking all kinds of assets including volatile markets, like oil or gold. If the market takes a hit, so will your investment. With actively-managed funds, you can buy and sell shares if you think that a certain market will drop in value.
Index funds perform best over time.
If you want to invest in an index fund and withdraw the money in six months, you could end up with less than your original investment. If you are looking for short-term investment opportunities, you might want to consider putting your money in individual stocks, like buying shares in one of the biggest tech companies in the world. Keep in mind though, that all investments come with risks involved and you could end up losing money, regardless of how safe you think the investment is.
Not all ETFs are simple to invest in and track.
ETFs are available in all forms and not all of them are index funds, even though the terms are sometimes used interchangeably in Australia.
You’ll have no control over holdings.
Index funds are set portfolios and you’ll have no control over individual holdings in the portfolio.
Bottom Line
If you find yourself flush with cash, maybe you have finally paid off your mortgage or received a large inheritance, and are thinking about investing, index funds are a great option. They are generally safe, low-cost and require no active management on your part.
That said, it’s important to remember that no investment is 100% safe. Carefully weigh the pros and cons and get to know the risks involved so you can make the best investment possible.
1. Can you directly buy an index fund?
Yes, you can directly buy an index fund. You can purchase index funds through online brokerages, investment firms, and even some banks.
2. What is the best index fund to invest in Australia?
There are several low-cost index funds in Australia to choose from, the most popular being the SPDR S&P/ASX 200 Fund (STW) which tracks the performance of the 200 biggest and most profitable publicly listed companies in Australia.
You are not limited to Australian index funds only, as you can choose to put your money in investment funds that track the performance of global companies.
3. How do I get the S&P 500 index fund in Australia?
The S&P 500 tracks the 500 biggest publicly-traded companies in America. Investing in a fund that tracks this index, is the same as investing in any index fund. Find a broker, provide the necessary documents and start trading.
4. How do I start buying index funds?
When you’re looking for how to buy index funds in Australia, you’ll want to consider your needs, investment style and ultimate goals. Once you’ve got all that figured out, it’s just a matter of finding the right fund and opening a brokerage account.
