You may be at a point where you have saved up some cash and are ready to start investing.
Or maybe you can now afford to invest a percentage of your take home income every month.
Whatever your situation may be, you may now be asking: what should I invest my money in?
You may have heard of Index Investing. But the question is: what is it and how does it work?
Index investing is a stock market investment strategy where you invest in an Index Fund(s).
It takes the guesswork out of investing by investing in the total growth of the stock market.
The benefits are that your money can’t hit zero, is low in fees, and has a great performance.
In this article, I talk about what index investing is and why your investments cannot hit zero.
I also talk about its low fees and its high performance, compared to actively managed funds.
Finally, I talk about how to get started in index investing and where to find more information.
1. What is Index Investing?
Index investing is all about investing in so called index funds – investment funds that track a benchmark index (a collection of companies) such as the S&P 500, FTSE 100, Nasdaq 100, etc.
When you invest in index funds, your money is invested in all the companies that make up those index funds, which gives you a diverse portfolio than if you just buy individual stocks.
Let’s look at the FTSE 100 – it’s an index fund that tracks the 100 largest companies in the UK.
Investing in this fund means your investment is tied to the performance of those companies.
Index investing is naturally diversified and thus is a lower risk than individual stock picking.
Index funds tend to have a great track record also – 10% average annual returns over time.
Index investing is regarded as a form of passive investing – it’s just investing in index funds. This is what sets it apart from actively managed funds, which you can read more about here.
2. Your Investments can’t reach Zero
What’s everyone’s biggest fear when it comes to investing? You end up losing all your money.
With Index investing, you don’t have this problem: since an index owns a lot of companies, it is impossible for it to crash to zero.
Individual companies may go bankrupt, but unless every single company was to go bankrupt at the exact same time, the index fund would never crash.
That is because with index investing, index funds own shares weighted by the market cap.
In other words, if a company is worth more, the index owns more shares of that company.
Similarly, if a company is worth less, the index owns less shares of that company.
This is how most index funds operate, such as the S&P 500 – an index fund which tracks the top 500 companies in the USA.
In fact, if a company where to drop in value from position 500 to 501, it would get removed from the index and the new position 500 company would take its place!
3. Index Investing has Low Fees
Actively managed funds are notorious for their fees, in the form of ongoing charges fee (OCF).
Depending on where you are in the world, these fees can be anywhere from 1-2%, if not more.
This may not seem like a lot – after all, it’s only 1% – but when you compare this to index investing where a typical index fund has an OCF of 0.10 – 0.3%, it makes a huge difference.
To visually see the impact of fees over the long term, check out this tool at alandonegan.com.
It shows you what would happen to your money if you invested in an actively managed fund.
The thing to note about fees is that you don’t get a bill at the end of year with a sum to pay.
If you did – and found you had to pay £1000 – you would charge your investing immediately.
Instead, the fees are taken from your investments quietly, every month. You never get a bill.
When comparing actively managed to index fees, you see why it makes sense to index invest.
4. Index Investing has Great Performance
The thing about actively managed funds is that they try to beat or outperform the market.
Statistically, only around 15% of actively managed funds outperform the market every year.
However, it’s not the same actively managed funds that outperform the market each year.
That means that it is a different 15% of actively managed funds that do well every year.
Therefore, this means that index investing beats 85% of all actively manged funds each year.
Surely you would expect to pay less fees to an actively managed fund if it doesn’t perform as well as index funds right? After all, you would expect high fees equals to higher performance.
Nope, that is not how it works – you pay the high fees whether the fund does better or worse.
Basically, actively managed fund investing has high fees with a 15% chance of outperforming index investing with low fees with a 85% chance of outperforming actively managed funds.
5. How to get Started
Here is how I would get started with Index Investing (particularly for people in the UK):
- Go to Vanguard, which is a global investment platform, and create an account with them.
- Open an Individual Savings Account (ISA), which lets you invest up to £20k tax free a year.
- Choose Vanguard FTSE Global All Cap (Accumulation) as the global index fund to invest in.
- Invest a lump sum (min £500) or invest monthly (min £100) and leave your money to grow.
To find out more about Index Investing, check out Rebel Finance School and alandonegan.com
If you want to read more on index investing, check out the book: The Simple Path to Wealth.
Are you investing at the moment? What are you investing in? Share in the comments below.
To learn about actively managed funds, check out: stock market investing: 3 ways of investing.
If you have any suggestions for future blog post topics, please share in the comments below!
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