What are Index Funds

A guide to Index Funds, and whether you should invest.

Every night the TV newsreader says: ‘and in finance news, the All Ordinaries closed lower/higher/flat today…’

You’d be surprised how many ‘informed’ news watchers have absolutely no idea what the All Ordinaries is.

The All Ordinaries is an index that tracks the overall movement of the share market by grouping together the largest companies and tracking their movement.

You can actually purchase very cheaply a fund that has 500 shares that constitutes the All Ordinaries. These are called ‘index funds’ and they don’t just track the All Ordinaries. There are plenty of indexes, such as the Standard and Poors, ASX Top 50, 100 and 200, as well as overseas indexes that you can gain an exposure to by investing in a local index.

Why are they cheap?

Index funds have low fees because they don’t employ highly paid fund managers to pick shares. All they do is invest in whatever makes up the All Ordinaries – not too much legwork involved in doing that.

Why would you want to do that?

There have been studies here and overseas that suggest that many active fund managers fail to beat the ‘market’ indexes (especially when you strip away all the fees they charge). Sometimes fund managers make mistakes and lose money, whereas if you’re investing in the market you’re always going to get the market return – which is the benchmark that most stockpickers use to see how well they’ve done.

Finally, they give fantastic diversification. As little as $500 will give you a very small holding in every one of those 200 companies that constitute the ASX 200.

Index funds are hugely popular, with trillions of dollars invested in them all over the world (you’ll probably find that some of your superannuation is invested in index funds). There is only really one retail index manager operating in Australia: Vanguard Investments. A downside to indexing is the minimum investment of $5000, which, depending on how much you’re regularly investing, can be limiting. once you do reach the minimum, you can Bpay additional amounts of $100+.

The best advice Buffett has for small investors is to put their dough into index-tracking funds because of their broad diversification and low costs. “A very low-cost index is going to beat a majority of the amateur-managed money or professionally managed money,” he said.

Read more articles on index funds by following the links below:

ETF’s – Exchange Traded Funds
Warren Buffett’s Guide to Index Funds

Read the Barefoot Investor Disclaimer

Photo: http://www.flickr.com/photos/haoli/3069725291/