It is important to keep in mind that it is extremely difficult, if not impossible, to consistently beat the market. Even with the ease of access of information because of the internet, “Buy low & sell high”, the oldest axiom in investing, is hard to time. Lucky for us, it is easy to join ’em if you cant beat ’em with the use of index funds. Investing greats such as Warren Buffett, John Bogle and countless others have been proponents of index fund investing.
Index funds replicate the movements of a specific benchmark index. There are a number of indices that track various components of the economy. Some of the popular ones are:
- Dow Jones Industrial Average – tracks 30 mega-cap US stocks
- S&P 500 – tracks 500 leading US corporations, a better measure of the US economy as it is broader.
- Russell 2000 – an index of 2000 small-cap US stocks
- Nasdaq Composite Index – an index tracking approx 3000 companies on Nasdaq
- S&P/TSX – tracks some of the largest Canadian corporations on Toronto Stock Exchange
- FTSE 100 – index of 100 companies on the London Stock Exchange
- Nikkei 225 – tracks 225 companies on the Tokyo Stock Exchange
The list goes on. There are various indices used in each country as a benchmark of the economy.
The indices listed above track various corporations in different industries but are associated geographically to where the index originates – for e.g., S&P 500 tracks American companies listed on one of US stock exchanges whereas S&P/TSX tracks Canadian companies listed on Canadian stock exchange. However, indices are not just limited to geographical locations – there can also be indices that target a certain sector of the economy such as Financials, Healthcare, Energy etc. A list of sector-based indices can be found here and here.
|20 yrs S&P 500 returns: Jun ’93-Jun ’13|
The chart above shows the returns for the last 20 years, Jun 1993 to Jun 2013, and the index has gone up by 257% – and that is without including the dividends. Click here for details of the annualized S&P 500 historical returns.
The goal for new starters needs to be to ‘keep it simple’. Fancy funds do not necessarily translate to better performance. They usually simply translate to a higher fees. Some key points to consider when investing using index funds are:
- Buy well diversified low cost funds
- Keep it balanced (pay attention to asset allocation)
- Optimize the tax efficiency
Vehicle to use
Investing in index funds can be achieved by using either mutual funds or ETFs. Using an index fund which stays true to the actual index with the least amount of overhead management fee should be the goal of the new investor. ETFs almost always have a lower fee compared to mutual funds and is the recommended vehicle to use. Vanguard, iShares and SPDR are some of the largest vendors for ETFs in the market.
There are a couple of different approaches that a new investor can take to have some diversification in the portfolio. The following articles are a good place to start:
- Target date funds – an all-in-one fund which automatically balances the asset allocation depending on the date.
- Three-fund portfolio – consisting of US stocks, international stocks and bonds.
- Lazy portfolio – a combination of low cost funds to take advantage of various market conditions.
- More lazy portfolios from CanadianCouchPotato, which gives more Canadian options. CanadianCouchPotato also has a great breakdown of the recommended ETFs for index investing.
I have the following index funds as part of my holdings. I own 4 funds for broad market exposure in US equities, Canadian equities, Canadian bonds and International equities. I also own 2 index funds which are sector specific.
- iShares 1-5 Yr Laddered Government Bond Fund (CLF)
- Vanguard US Total Market Index ETF CAD Hedged (VUS)
- Vanguard Total International Stock ETF (VXUS)
- BMO S&P/TSX Capped Composite Index ETF (ZCN)
Sector specific indices
- Consumer Staples Select Sector SPDR (XLP)
- BMO Equal Weight Utilities Index ETF (ZUT)
Remember, starting to invest is the hardest step. Once you get the ball rolling, you are on your way to secure financial future and a happy retirement.
Happy Investing! 🙂
Disclaimer: The information provided here is for educational purposes only. All opinions here are my personal opinions and should not be taken as financial advice. I am not qualified to be a financial advisor. Always consult with your financial advisor before investing in any of the companies mentioned on this blog.