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Index funds

Q. A friend of mine who has never been invested in the stock market has been talked into going into something called an index fund. She thinks it pretty safe and a good idea. What do you think?

A. Let’s explain index funds first and then pass judgment. An index fund is like an automatic investment fund set by rules and it does not rely on an individual fund manager or a team of stock-pickers who can get it very right or very wrong. In simple terms an index fund might buy all of the shares in the S&P/ASX 200 or even the top 20 stocks. It pockets the dividends and the capital gain and makes a return based on the movement of the market. They have a pretty good record and are not high risk but when stock markets crash they can be hit really hard. However, when the market rises they go along for the ride. I have seen studies over long periods that show index funds perform well against average fund manager-driven rivals. Importantly, because they have fewer workers picking stocks, they are cheaper. I know Warren Buffett, the legendary US investment guru has given index funds are big thumbs up for the amateur investor who wants a set and forget approach to building wealth. Keep in mind though that due to fees and charges and depending on how a fund obtains its exposure to an index, the fund may not 100% exactly mirror the relevant index. Note, it’s never smart to be invested into one asset class, such as shares, but if an index fund is to be your exposure to shares, it might be an OK strategy. Remember you should have shares, property, some interest-bearing securities and cash in a well-balanced portfolio. If you want to know more about index funds, you could look at the Fido website (ASIC) or Vanguard Australia website, which carry some good information. That said, I am not necessarily endorsing Vanguard’s funds to you, but their info on the website is useful.

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Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

 

Published on: Wednesday, October 21, 2009

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