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.
What are index funds?
Index funds pool funds from numerous investors to create a diversified portfolio, including stocks, bonds, or other assets. Fund managers maintain the asset allocation by tracking a specific index.
Notably, index funds often have low minimum investment requirements, providing investors with excellent liquidity as shares can be redeemed promptly.
Each share of the index fund represents an investor's proportional ownership of the fund's portfolio and the income generated by that portfolio.
Do your research and select an index fund that suits your financial goals and investment plan.
Use a "buy" order to purchase the index fund units through your stock broker.
Decide on a dividend strategy. If your index fund pays dividends, decide if you want them paid into your account or reinvested.
Track the performance of your index fund and sell your units depending on your investment strategy.
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.
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Finder survey: Which indices or themes do Australians invest in?
Response
I don't have any investments
70.02%
S&P/ASX 200 or S&P/ASX 300 (Australian stocks)
21.81%
S&P 500 (US stocks)
8.27%
Nasdaq (US technology stocks)
5.88%
Dow Jones
2.79%
FTSE 100 (UK stocks)
2.59%
VIX
1.79%
EURO STOXX 50
1.69%
Nikkei 225
1.69%
Source: Finder survey by Pure Profile of 1004 Australians, December 2023
How do index funds work in Australia?
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.
Video: Index funds Australia explained
Step 1. Sign up to an online stock broker
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 2024. 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:
Brokerage fees. This is the fee you pay every time you buy or sell stocks or ETF units. If you plan to invest regularly in your index fund, you'll want to find a broker with a lower commission/brokerage fee.
ETF screeners. Some brokers (such as CMC Markets) offer search tools that help you find ETFs depending on a set of criteria. For instance, if you wanted to find an ETF of major US tech stocks, you can use a screener to narrow down your choices.
Dividend reinvestment. If you decide you want any index fund dividends reinvested back into the fund automatically, make sure your broker has this as an option.
Access to the Australian Securities Exchange (ASX). If you plan to invest in a local index fund, you'll want to find a broker that offers access to the ASX.
Inactivity fees. Some brokers charge inactivity fees if you don't make a certain number of trades per year. These brokers are typically better suited to active traders rather than long-term investors.
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.
Step 2. Decide which Australian index fund(s) to invest in
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:
Broad-market index funds. These are your stock standard index funds. These hold a collection of company stocks that track a major stock market index, such as the ASX 200 or the S&P 500. You typically invest in these over the long term and they're considered one of the "safer" options because they're diversified across the entire market.
Sector-based index funds. These types of index funds track a specific sector of the market. For instance, the iShares Global Healthcare ETF (IXJ) tracks a collection of global biotech and healthcare-related companies. Other index funds track the mining, technology, financial and IT sectors, among others.
Market-cap index funds. Some Australian index funds hold a collection of companies based on their size (market capitalisation). For instance, as the name suggests, the VanEck Small Companies Masters ETF (MVS) only tracks companies with a smaller market cap. This can be useful if you want to invest beyond just the major companies held in broad-market index funds.
Smart-beta index funds. This is where you have an index that tracks a list of stocks based on certain factors, such as how volatile the stocks are, whether they have dividends and the strength of the company's balance sheet. Typically, these are just regular broad-market index funds with additional factors used to select stocks.
Commodity index funds. These index funds don't track stocks at all but commodity or currency prices. For instance, the BetaShares Crude Oil Index ETF (OOO) tracks an index of West Texas Intermediate (WTI) crude oil futures. These index funds are much riskier than ordinary broad-stock market index funds because they're tracking a single commodity.
Bond index funds. Bond index funds are often used to lower risk in investment portfolios. They hold a collection of bonds that may be local, global, corporate or government, depending on the index it tracks.
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.
Step 3. Buy your Australian index fund
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.
Step 4. Decide on your index fund dividend strategy
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.
Step 5. Track the performance of your index fund
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.
Why are index funds so popular?
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.
Right when savings accounts interest rates were super low, I was asked by a family member to help figure out the best thing to do with some money she wanted to put aside for some of her grandchildren. I explored savings accounts, trust funds and ETFs via finder and ended up settling on an Australian and an international ETF and it's been great to just watch it slowly grow after the initial setup.
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:
Vanguard Australian Shares Index ETF (VAS): Australia's most popular index fund by a large margin. This fund tracks the S&P/ASX 300 index, which is a portfolio of Australia's 300 biggest public companies.
Vanguard MSCI Index International Shares ETF (VSG): VSG tracks the MSCI World ex-Australia index and is a portfolio of major companies from around the world. It reinvests dividend and primarily holds major US companies.
iShares Core S&P 500 ETF (IVV): Tracks the S&P 500 index, which is a portfolio of the 500 biggest public companies in the United States.
SPDR S&P/ASX 200 (STW): Australia's first exchange traded fund. STW is similar to the VAS index fund except it tracks the S&P/ASX 200 index - Australia's biggest 200 public firms.
iShares Core S&P/ASX 200 ETF (IOZ): IOZ tracks the S&P/ASX 200 accumulation index. This is the 200 biggest companies but with all dividends re-invested.
You can also check out this year's top-performing index funds in our best-performing ETFs of 2024 guide.
Should you invest in an index fund ETF or a managed fund?
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:
ETFs are listed on a stock exchange. ETFs are traded like shares on the stock exchange while index funds are unlisted managed funds.
They're priced differently. The price you pay for an ETF is its market value, depending on its performance on the stock market. The price that you might buy or sell into an index fund is the net asset value of its underlying securities.
Buying and selling. ETFs can be bought or sold at any time during a trading day while managed funds are only priced at the end of the day.
ETFs have a lower minimum investment. Index funds typically require a higher minimum investment of more than $5,000. You can purchase many ETFs for less than $100.
Index funds don't charge a transaction fee. There's almost always a brokerage fee involved when buying or selling an ETF, but index funds tend to skip this cost. This means that a managed index fund can be a good option for investors looking to frequently add small amounts to their fund over time.
ETFs have lower fees. Taxation and management fees tend to be lower for ETFs than for traditional Australian index funds.
Compare online trading platforms to access index funds in Australia
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.
The benefits of investing in index funds
Index funds cost less.Passive funds require less legwork, so they typically charge lower fees than actively managed funds. In managed funds, high fees can easily eat into any returns gained by the broker.
Allow you to invest overseas. Certain index funds allow you to diversify through both domestic and international exposures.
They can achieve higher returns. Indices are proven to frequently beat the average returns achieved by fund managers over many years. Coupled with lower fees, they make good investing sense.
Ease of trade. Many ETFs listed on the ASX are index funds, which are easily accessible on brokerage platforms.
It can diversify your portfolio. Investing in an index fund offers access to various companies from different sectors.
They're relatively safe. Index funds are considered a safer alternative to direct stock market investing because indices are generally less volatile than individual stocks.
Tax efficient. ETFs are passive making them tax efficient. This makes them tax efficient as they don't sell very often, meaning they rarely have a capital gains event.
Of course, no investment is ever 100% safe. You should always seek professional advice before making any investment decision.
What are the risks of index funds Australia?
You could lose your money. Like any investment, you take the bad with the good. Your investment delivers profitable returns when an index does well, but when an index drops, so does your investment.
It's not a short-term plan. Passive funds perform best over many years. If you invest in an index fund but find you need the money 6 months later, there's a good chance you'll have less than you started with.
Not all assets are safe. Although many index funds track relatively safe major indices, any pool of assets can be bundled into a fund. Some index funds track volatile global markets such as oil while others bundle in riskier investment assets. Always do your homework.
Not all ETFs are index funds. ETFs come in all shapes and sizes. Not all are passively managed – some are highly complex and risky.
Indices news
Apr 2024: The S&P 500 has risen 1.57% over the past month despite unclear timing on US rate cuts. A Reuters poll has found the Australian dollar will look to start gaining in mid-2024 with a strengthening US economy and sticky inflation.
Mar 2024: Following reporting season, the S&P/ASX 200 index rose by 0.1% to close at 7733.50. This rise was helped by 6 out of 11 sectors ending in the green, including financial (+0.7%) and real estate (+0.5%).
Feb 2024: The S&P/ASX 200 index fell by 1% to 7603.20 points. This drop was led by weaknesses in the mining and financial sectors. The decline followed a period of gains and was influenced by the U.S. Federal Reserve's decision to hold interest rates steady, impacting global markets and investor sentiments.
Jan 2024: The S&P/ASX 200 index neared its record high, rising 0.5% to 7625.3 points, buoyed by gains in the mining sector and the steelmaking commodity price.
Dec 2023: The S&P/ASX 200 saw a 4% gain, driven by an improving global economic outlook, easing inflation concerns, and expectations of a slower pace in interest rate hikes.
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Frequently asked questions
A market index is a list of stocks that follow a certain theme. Most major indices are a list of the biggest stocks on an exchange. For instance, Australia's S&P/ASX 200 index consists of the 200 largest companies on our stock exchange while the S&P 500 index has the top 500 listed companies in the US.
There are companies that create these indices for fund managers to use. The best known is the S&P Dow Jones Indices and you'll see its namesake used in many major indices the world over.
Index fund investing is where you invest money into a specialised fund that tracks an index. Typically, you invest in index funds for the long term with the idea that by contributing regularly over time, your wealth will grow exponentially thanks to compound interest.
You can buy index fund ETF units through an online stock broker or you can apply to invest directly through the fund manager. It's worth noting that when you invest directly through a fund manager, you'll normally need a much higher minimum investment of between $5,000 and $100,000.
You can invest in many index funds by applying directly through the issuing fund manager. For instance, you could invest in a Vanguard index fund via an online stock broker (as an ETF) or by applying directly to Vanguard through its website.
To invest in an index fund ETF through an online stock broker in Australia, you typically need a minimum investment of $500. To invest in an index fund directly through the fund manager, the minimum investment could be anywhere from $5,000 to $100,000.
An ETF is a type of investment fund that is traded on a stock exchange. Index funds are investment funds that mimic the stock market. Most ETFs in Australia are also index funds. Index funds can also be super funds or regular unlisted managed funds.
Mutual funds and index funds are generally the same thing. While index funds are sometimes called "mutual funds" overseas (typically in the US), the term "index fund" more often refers to ETFs within Australia.
At the time of writing, Australia's cheapest index fund is the Vanguard US Total Market Shares Index ETF (VTS) with a management fee of just 0.03% p.a. That's followed by the iShares S&P 500 ETF (IVV) at 0.04% and the BetaShares Australia 200 ETF (A200) at 0.07%.
You can invest in Vanguard index funds by signing up to an online stock broker and buying Vanguard index fund ETF units. Alternatively, you can apply to invest in a Vanguard-managed fund directly through Vanguard.
Generally speaking, index funds are a good long-term investment if you're looking to gain exposure to the market. They are popular among retail investors because they take a lot of time and effort out of investing. By taking a position in an index, you own a small percentage of each stock, meaning you own a wide variety of stocks, usually for a pretty low cost.
Broad-based index funds attempt to capture a broad part of the stock market. They do this by holding a collection of the largest stocks in any one stock market. For instance, the ASX 200 index is used to track the performance of the Australian stock market and holds the 200 biggest companies in Australia.
Only some index funds pay dividends. If dividends are important to you, check the fund manager's website and the product disclosure statement for details on what the average dividend payout (yield) is and how often it's distributed.
Kylie Purcell is the senior investments editor and analyst at Finder. She has completed a Certificate of Securities and Managed Investments (RG146) and specialises in investment products including online brokers, robo-advisors, stocks and ETFs.
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