I’m new to the world of investing, but it wasn’t until I learned about index investing that I finally began to feel my power as an investor.
If you hear someone going on about investing passively, or buy-and-hold strategies, they’re probably talking about index investing and it’s physical earthly form: exchange-traded funds (ETFs).
Index investing is kind of a departure from the caricature we have of an investor:
It’s a lot more chilled.
Index tracking was invented to depart from the traditional active investor philosophy by a man named Jack Bogle, who sadly passed this year. He believed that, for all its enthusiasm and expert insider knowledge, active management couldn’t beat simplicity: buying broad, and holding forever.
An index-tracker is a basket of shares that tracks the market. It’s a product, entirely electronic, that forms a kind of picture of The Market. Some indices try to form as big and as complete a picture of the market as possible. Other indices try to track just one aspect of the market. There are indices for just about everything.
Popular ones, like the S&P500, track the top 500 companies in the USA, or the top 40 companies in the JSE (our local stock market). There are larger indices like the Ashburton 1200 or the Satrix MSCI World that track the global market, the emerging markets, the European markets. There are indices for property, precious metals, weed stocks, tech. You can index almost anything.
Index tracking is the concept, and ETFs, or Exchange-Traded Funds, are the actual products we buy when we passively invest. There are a ton more ETFs available to the average South African than there were twenty years ago. Financial service providers have really come around to the idea and most offer their own ETFs on their online platforms.
ETFs are kind of beautiful in their design, for a couple of reasons:
They’re cheap. Ridiculously so. ETFs are about as close to zero percent fees as you can get, especially in the bigger funds, where costs are spread throughout the customer base. The Vanguard 500 Index, for example, famously boasts a 0.04% expense ratio.
If you want an excellent and nerdy breakdown of why ETFs are the cheapest, I can recommend Nerina Visser’s JSE presentation on the subject of investment costs.
They’re diversified. The real strength of an ETF is that it’s protected against too much market volatility by its diversity. You’re not investing in one tech company, but fifty. When one of them turns out to be a fraudulent flop and drops to zero in a day, it falls out of the index and you, crucially, haven’t lost all your money in one fell swoop.
You get market returns. Lots of active managers and investors don’t like this about ETFs because it also makes their returns kind of boring. You’re only getting market returns on them, they argue. This is probably a diverging of investing philosophy; I am neither an active manager nor a hot-shot investor. I just want my money to be a) preserved and b) do better than inflation until I need it in my old age. In other words, I want to make as few stupid decisions with my money as possible, and I especially don’t want to delude myself that I’m smarter than the market. As we’ve already said, thinking you’re smarter than the market is an excellent way to lose a lot of money.
Taking the long view of market performance, the market always goes up, eventually.
Related: Shares vs ETFs
And boring? This was the Dow Jones over the last century.
Does that look boring to you?
They’re self-cleaning. If an index is there to track the 500 best companies in the market, that means that when a company falls out of favour with the market, they also automatically fall out of the index. While everyone’s freaking out about the latest disaster (*cough* Steinhoff *cough*) your portfolio’s barely taken notice.
They’re simple. They resist our normal human instinct to endlessly complicate the issue. They’re a buy-and-hold strategy and the surest way to undercut the progress your ETF has made is by tinkering with it.
Where do I buy ’em?
EasyEquities and ETFSA are great marketplaces to buy all kinds of ETFs. If you’re a fan of any particular ETF-holder, say Coreshares or Satrix, you can go directly to those brokers and buy there also.
So if index investing is so great, why does it come last in my financial plan? It doesn’t; as much as possible, I only want to invest in index funds, across all my types of accounts. My tax-free investments, my retirement annuity – I use index funds in all of them.
Article reposted with permission from Drawing Money.