Index Funds The Foundation Of Your Investment Portfolio

Index Funds The Foundation Of Your Investment Portfolio
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My philosophy for investing is to keep things as simple as possible. This is why it is a must for me to discuss Index Funds the foundation of your investment portfolio. When it comes to investing I like to start by building a strong foundation then adding to that foundation as needed. Index funds are a great way to build a solid investment foundation.

What Is an Index

An index is a collection of shares based on a specific criteria or categories. The criteria for the index could be any of the following.

  • Marked Capital – Based on the size of the companies, Large Cap, Mid Cap, Small Cap.
  • Market Sector – Financials, Health Care, Energy, Consumer Staples, Property.
  • Geographical Location – Australian, International, Emerging Markets.
  • Return or Market Type – Dividend, Growth, Value.

If you watch the news in Australia you have probably heard of the All Ordinaries index and maybe the ASX 200. In the US it would be the Dow Jones Industrial Average or Standard and Poors 500. The All Ordinaries Index is considered to be the total market barometer for the Australian stock market. The ‘All Ords’ is a collection of the 500 largest companies listed on the ASX (Australian Stock Exchange) by market capitalisation. The Index was established in 1979 and accounts for just over 75% of the Australian equity market.

You can purchase a fund that tracks a particular index, these are called ‘Index Funds’ and can be a cheap way to get a large basket of shares with a single transaction.

Low Fees

Index funds have very low fees because there are no expensive fund managers picking stocks. All the fund does is mirror the index that they are tracking. The fees are also lower due to the fact there are less buy and sell transactions going on within the fund. There is also no need for the fund to hold large amounts of cash or sell stocks at a loss when many investors leave the fund. You can read my post on the effect of fees on an investment.

Why Invest in Index Funds

There are many studies that have been done over the years that show that actively managed funds generally fail to beat their comparison indexes. The value added by a fund manager is rarely more than the additional costs incurred by actively managing the portfolio. Index funds are great for building a diverse portfolio without having to hold a large number of individual stocks. Diversification reduces the risk by spreading your investments over various financial categories like the ones listed above. There are in-fact entire world index funds and index funds with Bonds included.

How to purchase Index Funds

Perhaps the easiest way to purchase index funds is through an ETF (Exchange Traded Fund). These can be bought and sold the same as individual stocks through a broker. The other option is to use a company such as Vanguard who have a large offering of index funds in Australia and across the world. There is a massive trend at the moment where investors are moving from managed funds to low cost index funds.

Some Examples of Index funds that I have in my investment portfolio include.
VAS:AU – Vanguard Australian Shares Index ETF. Vanguard Australian Shares Index ETF seeks to track the return of the S&P/ASX 300 Index.
VGS:AU – Vanguard MSCI Index International Shares Excluding Australia. Vanguard MSCI Index International Shares ETF seeks to track the return of the MSCI World ex-Australia.
VGB:AU – Vanguard Australian Government Bond Index. Vanguard Australian Government Bond Index ETF seeks to track the return of the Bloomberg AusBond Govt 0+ Yr Index

Index funds provide a simple vehicle to build a Diverse Low Cost Portfolio of Stocks that can be the foundation of your Investment Strategy.

Now that you know what Index Funds are and what they offer I would be interested to hear if you use index funds as part of your portfolio. Are you one of the many investors moving to low cost index funds?

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