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You may have heard about index funds from the likes of the Barefoot Investor or the world renowned investor Warren Buffet.
An index fund is an investment portfolio that tries to mimic a financial market – typically the stock market. They're popular because the fees are usually lower and they're thought to be safer than other kinds of investments.
In Australia, you can also invest in unlisted index funds (managed funds) directly through many fund providers, such as Vanguard Investments or BlackRock. However, you'll typically need to pay a high minimum investment of between $5,000 and $100,000 depending on the fund manager.
You can sign up to an online broker by selecting from one of our top picks below or comparing your options in our stockbroker comparison table.
Index funds are investment funds that hold a selection of stocks that make up an index. When it comes to investing, index or indices refer to a collection of stocks, bonds or other financial instruments, that can be used to track the performance of an entire market.
Traditionally, an index fund tracks a broad-based market index which is hundreds of the largest companies a country has to offer. For example, Vanguard's Australian Shares Index Fund tracks the ASX 300 index, Australia's largest 300 companies.
Index funds simply try to replicate the performance of a market by constructing a portfolio that matches the index itself. As such, the idea is they simply follow the performance of the market rather than trying to outperform it.
Index fund investing is known as "passive investing" because the fund managers aren't actively buying or selling assets to try to outperform the market; they're simply following it. If a company leaves an index (e.g. it collapses), the fund manager sells its shares and replaces them with new stocks.
Many types of investment funds can be index funds, including ETFs, some superannuation funds, robo-advice funds and regular managed funds.
The simplest and cheapest way to invest in an index fund is through an exchange-traded fund. To invest in an ETF, you'll need to open an account with an online stock broker or share trading platform.
There are at least 40 online brokers available in Australia as of 2023. To find the best broker for you, select one with low brokerage fees, no ongoing account fees and features that suit your needs best.
Here are some features to consider when choosing your broker:
It's worth noting that some online trading platforms (such as Superhero and Pearler) offer a $0 brokerage deal on ETF purchase orders, meaning you can add funds to your ETF as often as you like without paying additional trade fees.
There are hundreds of index funds available in Australia and not all of them are "lower risk" investments, so it pays to do your homework.
You should also check what management fees you'll be charged by the fund manager. The most common fee is the management expense ratio (MER) fee. The average ETF management fee is around 0.5% p.a. of your total portfolio. If you plan to invest for the long run, high management fees can make a big difference.
Here are some of the main types of index funds in Australia:
Before you decide which type of index fund is best for you, the first step is to think about your investment strategy. Do you plan to stay invested in your index fund for 10 years or more? Or are you simply trying to invest in a short-term trend, such as gold prices?
If investing for many years, you'll want to check out the broad-market index funds. If it's the latter, the sector-based or commodity index funds might be more suitable.
There's no limit to the number of index funds you can invest in at one time. For instance, you could invest in both an S&P500 and ASX200 index fund for exposure to both the Australian and US markets. To diversify further, you could even invest in emerging market funds, bonds or property index funds.
Technically you're buying index fund units. These are similar to stocks, but when you buy a unit of an index fund or ETF, you're investing in a whole collection of stocks in one go.
If you're investing in your index fund through an online stock broker, you'll need to search for your ETF within the platform.
It's easiest to search for the fund using the ticker code. This is a 3- or 4-letter unique code that every ETF and stock has. For instance, the ticker code of Vanguard's Australian Shares Index ETF is "VAS".
You'll then need to purchase your ETF units using either a "market order" or a "limit order". A market order buys the units for whatever the current rate is (at the time the order goes through). A limit order allows you to set a specific price.
A limit order can be useful if the stock market is especially volatile. You can set a limit order to ensure you don't purchase units during an unexpected price spike.
Some index funds in Australia pay out dividends. If you've selected a dividend-paying index fund, you'll need to decide whether you want the dividends paid out to you or reinvested back into the index fund.
Index fund and ETF dividends are automatically paid into your selected bank account. If you'd prefer to reinvest, you'll need to sign up for a dividend reinvestment plan (DRP).
To participate in the DRP, you need to complete a DRP instruction form and return it to your ETF's share registry.
There are several share registries in Australia. You'll find your ETF's share registry on its website or in the product disclosure statement (PDS). When you invest in the ETF, you should also receive a statement in the mail from the share registry with contact details.
However, this will only work if your stock broker offers CHESS-sponsored shares and ETFs. If you use a custody-model broker, you'll need to check whether the platform offers a DRP option.
Index fund investing is all about investing for the long term, so don't worry too much about the daily ups and downs of the stock market.
If you plan to hold your Australian index fund for many years, try not to check on its performance every day. Instead, think about taking stock every few months or so.
When it's time to sell, you'll follow a similar process as when you purchased the index fund units.
You'll need to sign in to your stock broker, navigate to your index fund and select either a "market" or "limit" sell order.
Index funds are proven to outperform many other kinds of investments over many years.
In 2008, one of the world's most successful investors, Warren Buffet, made a $1 million bet that a bundle of actively managed funds would be worse off than the S&P 500 over 10 years. He argued that if a fund mimicked a major index, it would deliver better returns than a fund actively managed by professionals.
Buffett's ultimately successful wager showed that net of fees, an S&P 500 index fund would outperform a hand-picked portfolio.
Although major indices fluctuate from year to year, they usually rise over a long time. For example, the ASX 200 index fell by more than 15% during the 2008 global financial crisis. But even if you had invested in the index fund just before that, you'd still be in a better financial position today than if you'd not invested at all.
There are more than 200 index funds to choose from in Australia and most of these aren't labelled "index funds", so it can be tricky to source a full list.
Here are the most popular index fund ETFs in Australia (by funds under management) at the time of writing:
You can also check out this year's top-performing index funds in our best-performing ETFs of 2023 guide.
Many fund managers offer index funds in both their ETF forms or as a regular (unlisted) managed fund.
For instance, if you wanted to invest in Vanguard's Australian Shares Index (VAS), you have the option of investing directly in the unlisted managed fund through Vanguard or buying units in its ETF counterpart of the same name through a stock broker.
The biggest difference between an ETF and an unlisted managed fund is that an ETF can be traded during the day like a stock while units in an (unlisted) managed fund are bought and sold only for the price set at the end of the trading day.
The following are some other noticeable differences:
You'll need a broker to invest in an index fund ETF.
Important: The standard brokerage fee displayed is the trade cost for new customers to purchase $1,000 of either Australian or US shares. Where a platform charges different fees for both US and Australian shares we show the lower of the two. Where both CHESS sponsored and custodian shares are offered, we display the cheapest option.
Of course, no investment is ever 100% safe. You should always seek professional advice before making any investment decision.
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