Index funds are an incredible tool for investors looking for a passive, or ‘hands off’ way to invest their money across multiple shares, and other asset classes. There are a few ways you can invest in an index, most commonly through a managed fund or ETF. In this article, I’ll talk you through how to invest in index funds in Australia through ETFs in 5 simple steps.
How To Invest In Index Funds (Australia) – Contents
- What’s an Index?
- Why Invest In An Index?
- ETF? Index Fund? What’s The Difference?
- 1: Open An Account With An Online Broker
- 2: Decide On Your Investment Amount
- 3: Choose Your ETF
- 4: Figure Out How Much To Buy
- 5: Place Your Order (Buy)
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What Is An Index?
An index is essentially a hypothetical portfolio of investments designed to capture the performance of a particular section of the market. All indexes have varying purposes, with each one designed to track the performance of a different basket of securities that represent various share markets across the globe.
A common example of an index is the S&P 500. The S&P 500 is a market capitalisation weighted index that tracks the performance of the largest 500 listed companies in the U.S.
For the purposes of this article, I’ll only be referencing indexes tracking share markets. It’s important to be aware that there are other indexes out there tracking other asset classes and economic data more broadly. For example, Barclays Capital U.S. Aggregate Bond Index is a broad benchmark index for the North American bond market.
Indexes Are a Handy Yardstick.
In addition, major Investment indexes like the S&P 500 or the S&P/ASX 200 here in Aus are often viewed as barometers of a country’s economic performance because they track a large portion of the overall market.
They’re also a handy yardstick/benchmark for investors attempting to achieve higher rates of return than the index or ‘beat the market’ by trying to pick individual stocks they think will outperform the index.
Why Invest in the Index?
While all active investors like to believe they can outperform benchmark indexes, very few have consistently ‘beat the market’ average over an extended period of time.
The S&P Global SPIVA report revealed 86% of General Australian Equity Funds were outperformed by S&P/ASX 200 Index over a 15 year period. Meanwhile, by just buying and holding an index, you would have done better than 86% of the ‘experts’.
The Index Does All the Heavy Lifting For You
The beauty of investing in an index is that you don’t need to worry about trying to pick winners and sell losers. You’ll simply own the whole market, and earn your share of the market’s return. History says you’re likely to do better tracking the indexes anyway.
Don’t believe me? Here’s what the Investing Guru, Warren Buffett has to say about index investing.
“A low-cost index fund is the most sensible equity investment for the great majority of investors.”
ETF? Index Fund? What’s The Difference?
Retail investors can easily access the returns of almost any index thanks to the advent of ETFs right here on the ASX (Australian Securities Exchange).
Firstly, ETFs come in all shapes and sizes nowadays, but there are a few designed to mirror the returns of broad-based indexes like the ASX 200, or S&P 500 by buying the companies forming the index for you.
Secondly, broad-based index-tracking ETFs are also super cheap because they’re completely passive (index tracking). That’s because ETF providers don’t need to pay a fund manager to pick stocks for the fund, saving you on fees.
Some of My Favourite Index Tracking ETFs ⬇️
For your convenience, I’ve collated some of my favourite broad-based index-tracking ETFs listed on the ASX below.
|ASX ETF Ticker Code||Underlying Index|
|VGS*||MSCI World Ex-Australia Index|
|VTS||CRSP US Total Market Index|
|VEU||FTSE All-World ex-US Index|
*For full disclosure, I own units in VGS and NDQ.
How To Invest In Index Funds (Australia) – Step 1: Open An Account With An Online Broker
The first thing you’ll need to do to start index fund investing is to set up a share trading account with an online stockbroker.
A broker’s job is to buy and sell shares on the share market on our behalf. For their services, we pay them a brokerage fee, which varies from broker to broker. The good news is, fees are getting lower as online brokers fight for supremacy.
Choosing a Broker
There are a plethora of online brokers out there nowadays, but don’t let that overwhelm you. Have a quick look over their brokerage fees and features and open an account. You can always move brokers later if you come across a better offering.
Personally, I hold my investments through Commsec. That said, my investing style aligns strongly with Pearlers ‘get rich slow mantra’.
If you decide Pearler is the broker for you, you can use this affiliate link to get your first trade for free on me!
You can also check out my interview with Pearler Co-Founder, Nick Nicolaides to get a feel for what Pearler is all about.
How To Invest In Index Funds (Australia) – Step 2: Decide On Your Investment Amount
The amount you invest will be dictated by your budget, and overall income. That’s why it’s important to consider creating a budget tied to your financial goals before committing to regular investing. That way you know the exact amount you’ve allocated to invest each month.
Knowing how much you’re regularly investing also gives you a sense of how much you’re paying in brokerage fees.
Calculating Your Brokerage Fees
Let’s say your broker charges $10 per trade for all investments totalling under $1,000 or under.
If you invested $1,000, 1% of your investment is chewed up by fees (1% of $1,000 = $10)
On the other hand, if you invested $500, 2% of your investment will be paid in fees (2% of $500 = $10)
That might not sound like much, but over time those fees add up!
|Investing $500 per month over 5 Years at $10 per trade.||Investing $500 every two months over 5 years at $10 per trade.|
|Brokerage Fees Paid||$600||$300|
As you can see, serious savings can be made when you consider the sequence of your investment to ensure you maximise every dollar!
All in all, it’s key to plan ahead and keep it consistent. If you’re interested in learning how I budget to facilitate my investing practice, have a read of this.
How To Invest In Index Funds (Australia) – Step 3: Choose Your ETF
Once you’ve selected a broker, and know how much you have to invest, it’s time to select an ETF.
Selecting the right ETF has become increasingly difficult over the years as more of them have popped up.
According to Statista, there were 7,602 ETFs available worldwide in 2020, up from 276 in 2003!
Choosing The Right Type of ETF
Not all ETFs passively track broad-based share market indexes. Some ETFs are actively managed, meaning they do not track an index because they’re trying to beat one!
The good news is, finding the right ETF becomes a lot easier when you know what you’re looking for!
Here are a few important things to consider to ensure you’re sticking to the ETFs tracking broad-based share market indexes.
- What Asset Class is the ETF Tracking? (Shares, property, bonds, etc)
- What Region Does The ETF Cover? (Australia, America, Europe etc)
- What is the underlying index? (Look for ETFs tracking broad based share market indexes like the S&P 500, ASX 200, Nasdaq-100, MSCI World Index etc)
- Who Is The ETF Issuer? (Vanguard, BetaShares, iShares, etc)
- What are the fees? (Index tracking ETFs will usually have lower fees than active ETFs)
If you’d like more detail on each of these points, check out this article I wrote on the 6 things you need to know about an ETF before investing.
Additionally, you can have a flick through an ETFs fact sheet found on the ETF providers website to grab those juicy details.
How To Invest In Index Funds (Australia) – Step 4: Figure Out How Many Units In The ETF To Buy
The number of units in an index tracking ETF you buy will depend on three things.
- The amount you’re investing.
- The price per unit of the ETF.
- Brokerage fees
For this example, let’s assume you’d like to invest a maximum of $1,000 into ASX: VGS. VGS is currently priced at $104.35 per unit (5 November 2021). $1,000 / $104.35 = 9.6 Units.
To ensure you stay below your $1,000 cap, you’ll need to buy 9 units because most brokers don’t allow fractional share purchases of ETFs.
Adding in the Brokerage Fees
By taking the per-unit price ($104.35) and multiplying it by 9 units, the order sits at $939.15.
Lastly, brokerage costs will be added. Assuming the brokerage cost for this trade is $10 (this will vary from broker to broker), the total order cost comes in at $949.15 ( $10 + $939.15).
How To Invest In Index Funds (Australia) – Step 5: Place Your Order (Buy)
Lastly, it’s time to place your order.
Placing Your Order: A Working Example
I’ve used my brokerage account on Commsec for the purposes of this example, but don’t fret! Other brokers UX won’t be too dissimilar.
Step 5a: Finding Your ETF & Selecting Buy
Firstly you’ll need to search for the ETF you’d like to purchase by searching its ticker code within your broker’s platform, i.e. “VGS”. Once you’ve found it, select “Buy” as per figure 1 below.
Step 5b: Adding In The Finer Details
Secondly, you’ll need to confirm a few details regarding your order as per figure 2 below.
If you’re investing in a broad-based index-tracking ETF, it’s likely you’re planning to hold it for the long term as a passive investment. That’s why it makes sense to place a market order when making your investment (generally speaking).
Additionally, there are some nifty ways to place orders like placing a limit or other price-based orders, however, these are best suited for shorter-term, active investments. I cover these off in this article if you’re interested.
The expiry option you choose is largely dependent on the security you’re investing in. For highly liquid broad-based index-tracking ETFs like VGS, A200 or IVV, you should have no trouble getting your order fulfilled in a day.
Step 5c: Confirming Your Order
Lastly, you’ll be prompted to review and submit your order. And that’s it, you’re done!
Settling On Your ETF Units
Online brokers require you to have adequate funds in your share trading account to cover the cost of your investment. The amount you need to transfer will be a combination of the amount you invested plus any brokerage and/or additional transaction costs (refer to step 4).
All trades on the ASX and Chi-X settle after two business days. That means your account needs to have sufficient funds available beforehand to avoid paying excess fees from your broker.
How To Invest In Index Funds (Australia) – Summary
To sum up, tracking certain major share market indexes through ETFs has proven to be a hugely effective strategy for investing in the share market over the long term thanks to the powerful combination of compound interest, and low fees. Check out this Vanguard Index Chart to see what I mean.
While that’s awesome, it’s important that you consider your personal situation, financial goals and appetite for risk before making an investment decision.
In conclusion, here’s a legendary quote from the Father of modern index investing.
“Don’t look for the needle in the haystack. Just buy the haystack!” – John C. Bogle, Founder of Vanguard.
About The Author – Jesse
Hi, I’m Jesse, but you can call me Jes for short. My passion is simple, I’m on a mission to make the world of investing easily understood by removing the ‘too hard basket’ stigma that surrounds it.
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Disclaimer: This website (the “The Money Pal”) is published and provided for informational and entertainment purposes only. The information in the Blog constitutes the Content Creator’s own opinions and it should not be regarded as financial advice.