How to invest in index funds in Australia

Get access to a bundle of stocks through a low-cost index fund by following our beginner's guide.

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If you’re interested in investing, you’ve probably heard about index funds. An index fund is a low-cost investment product made up of stocks or other assets that tracks a financial market index.

But how do they work and what makes them different to other kinds of funds? This guide cuts through the financial jargon to cover everything you need to know about index funds in Australia and why they're creating so much buzz.

How to start investing

If you already understand what index funds are and want to start investing, you can do so through a fund manager, a full service broker or an online share trading platform. One of the easiest and cheapest ways to access index funds is via exchange traded funds (ETFs) which are traded on the Australian Securities Exchange (ASX).

Before you do so, you should know that not all ETFs are index funds and some funds are riskier than others – you can read more about this below. Ready to invest? The following table shows some of the share trading platforms you can use to access index funds.

Compare online trading platforms to access index funds

Updated September 21st, 2019
Name Product Monthly fee Standard brokerage fee for ASX shares Margin trading - Online International
$0
$8.00 or 0.1%
Yes
Yes
Special offer: Earn up to 10,000 Qantas Points when you start trading on a new IG Share Trading account. T&C applies.
Enjoy some of the lowest brokerage fees on the market when trading Australian shares, international shares, forex and CFDs, plus get access to 24-hour customer support.
$0
$6.99 or 0.1%
Yes
Yes
High quality, low-cost brokerage on global share trading.
Access up to 19,000 global stocks on 36 of the world’s major stock exchanges and enjoy some of the most competitive FX rates on the the market when you trade with Saxo Capital Markets.
$0
$9.50
No
No
Trade ASX-listed shares for a flat fee of $9.50, regardless of the trade size. New customers receive free access to Community Insights with SelfWealth Premium for the first 90 days. Follow other investors and benchmark your portfolio performance.
$0
$15 for first 10 trades
Yes
No
Offer: For a limited time, get a custom deal based on your trading preferences when you switch to Bell Direct.
Bell Direct offers a one-second placement guarantee on market-to-limit ASX orders or your trade is free, plus enjoy extensive free research reports from top financial experts.
$0
$11 or 0.1% for first 10 trades (for trade value up to $11,000)
Yes
Yes
Access a broad range of investment products from Australia and overseas.
Take advantage of IPOs and trade shares, warrants, options and CFDs listed across the ASX, SSX and Chi-X, and other major global exchanges, including US, Canada and UK markets.

Compare up to 4 providers

What are index funds?

A typical managed investment fund is a collection of stocks and other assets. Instead of buying shares in one company, you can invest in a bundle of them. To deliver profits for their clients, fund managers buy and sell assets within the fund by trying to predict market movements. This difficult feat is known as "active" management.

An index fund is handled differently. It's simply a pool of company stocks that mimics a financial index, requiring little intervention from its fund managers.

What is a stock market index?

To understand an index fund, it's important to know what an index is. A market index is normally a collection of stocks that are listed on a stock exchange. Australia's most well-known index is the ASX200, which consists of Australia's largest 200 companies by market capitalisation. The Wall Street alternative is the S&P 500 index, which includes the top 500 listed companies in the US.

You'll notice these indices are frequently cited in the media because investors use them to track the overall performance of a market. They rise and fall depending on a range of economic indicators and company news. For example, when an economy is healthy, its stock market indices tend to rise because investors feel more confident buying stocks. If trade tensions increase between countries, stock market indices usually fall as investors become nervous.

How do index funds work?

Index funds hold a selection of stocks that make up an index. For example, Vanguard's Australian Shares Index Fund tracks the ASX300 index, a collection of Australia's largest 300 companies.

If a company leaves an index, the fund manager simply sells its shares and replaces it with new stocks. For this reason, index funds are considered a comparatively safe, albeit less exciting, alternative to directly buying shares in a company.

Because these kinds of funds require minimal management, it's known as "passive" investing.

It's important to note that while index funds are sometimes 'mutual funds' overseas, within Australia, the term "index fund" more often refers to exchange traded funds (ETFs).

What is an ETF?

An ETF is a basket of securities that's listed on a stock market, such as the ASX. In Australia, ETFs are typically "passive" investments that track an asset or index, but this isn't always the case. You can read more about ETFs in our informational guide.

Confused about the terminology? That's because terms are changing all the time and actually vary across different borders. Despite the popularity of traditional managed (sometimes called mutual) index funds in the US and other countries, there are few such options available in Australia. Instead, many Australian investors use ETFs to track indices as they work in much the same way but are broadly easier to access and have a lower minimum cost requirement.

The difference between an ETF and traditional index fund

Most ETFs are similar to traditional index funds in that they are low-cost and track a major underlying index, though there are a few key differences:

  • ETFs are listed. The main difference is that ETFs are traded like shares on the stock exchange while index funds are unlisted managed funds.
  • They're priced differently. The price that 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, whereas managed funds are only priced at the end of the day.
  • ETFs have lower minimum investment. Index funds typically require a higher minimum investment of more than $5,000. Many ETFs can be purchased 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. On the other hand, taxation and management fees tend to be lower for ETFs than traditional index funds.

Why invest in an index fund?

Simply put, index funds have been proven to outperform many other kinds of investments.

In 2007, one of the world's most successful investors, Warren Buffet, made a $1 million bet that a bundle of active managed funds would be worse off than the S&P 500 over 10 years. He argued that if a fund simply mimicked a major index, it would deliver better returns than a fund actively managed by professionals. A decade later, Buffet won that bet.

The point is that although major indices fluctuate from year to year, they usually rise over a long period of time. For example, the ASX200 index fell by more than 15% during the 2008 global financial crisis. But even if you had invested in the index fund just prior to that, you'd still be in a better financial position today than if you'd not invested at all.

What are the benefits of investing in an index fund?

  • 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.
  • They can achieve higher returns. Indices have been 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 broking platforms.
  • It can diversify your portfolio. Investing in an index fund offers access to a range of companies from various 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.

Of course, no investment is ever 100% "safe" and you should always seek professional advice before making any investment decision. Here are some of the risks that investors need to be aware of:

What are the risks of index funds?

  • You could lose your money. Like any investment, you take the bad with the good. When an index does well, your investment delivers profitable returns, 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 six 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, technically any pool of assets can be bundled into a fund. Some index funds track volatile global markets, such as the oil sector, while others bundle in riskier investment assets. Always do your homework.
  • Not all ETFs are index funds. ETFs come in all shapes and sizes and not all are passively managed. Some are highly complex and risky. You can read more about different kinds of ETFs here.
NAMEINDEXTYPE
SPDR S&P 500 ETF TrustS&P 500ETF
iShares Global 100 ETFS&P Global 100ETF
SPDR S&P/ASX 200 FundS&P/ASX 200ETF
Vanguard Australian Shares Index ETFS&P/ASX 300ETF
Vanguard Index Australian FundS&P/ASX 300Index fund
iShares North America Index FundMSCI North AmericaIndex Fund

Steps to invest an index fund

Most major fund managers offer access to a limited pool of index funds, though ETFs are the more readily accessible option within Australia.

Traditional index funds can be purchased directly through their associated fund providers, such as Vanguard Investments or BlackRock. ETFs can be purchased with any regular stockbroking account.

Whether you want to invest in an ETF or an unlisted index fund, these are the steps you need to follow:

1. Consider your strategy

Ask yourself what you want to achieve through this investment. Consider your time frame and how much risk you're willing to take on. Will you need to withdraw the funds in a year's time or can they sit for 10 years?

2. Assess your options

Compare funds online to find a product that matches your goals. Consider the risks, the fund's performance, the brokerage fees and other transaction costs.

Key things to take into account when deciding on an index fund:

  • Management
  • Brokerage fees
  • Transaction fees
  • The fund's performance over the last 3, 5 and 10 years
  • Are the fund's assets safe or does the fund contain some volatility?
  • The minimum investment amount and how often you plan to transact with the fund

3. Sign up through a fund manager or online broker

Once you've found the right product, you'll need to work out the best way to access it.

Index funds can be accessed through their fund providers such as BlackRock or Vanguard Investments.

  • When applying directly to a fund manager, you'll need to fill out an application form, provide proof of address, ID and tax file number. This will need to be posted or emailed back with a cheque or proof of transaction.
  • Financial planners can also apply for an index fund on your behalf.

Some online brokers such as CMC Markets have access to managed funds through a settlement service, such as the ASX's new mFund, but at the time of writing there are no index funds accessible via the mFund service.

ETFs are accessible on most online trading platforms and can be purchased just like any other stock. You'll need to sign up for an online share trading platform. To do this, you'll need to:

  • Provide personal details and proof of ID
  • Transfer money into your trading account
  • Log in to your account
  • Search for the ETF you want and place a buy order

For more information about ETFs make sure to check out our extensive guide.

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