Indexing basics

Indexing is a simple, low cost investment strategy designed to deliver consistent, long term performance by capturing the market returns.

How does indexing work?

An index fund invests in all (or a representative sample) of the assets that make up a market.

Indexing is great for long-term investments such as superannuation because it delivers competitive long-term performance and it helps us offer you low management fees, so more of your money is working for you.

Unlike some actively managed funds, indexing doesn’t rely on analysts and brokers who try and pick the ‘hot’ stocks to beat the market.

Instead, your super is invested more broadly. So for example, when we invest in Australian shares, we invest in the 300 largest public companies (or a representative sample of these) to closely match the performance of the ASX300. This investment strategy reduces risk and fees, and aims to achieve market returns year after year.

Have a look at this table to see how indexing stacks up against more ‘active’ types of investment.

How does indexing compare to active investing?

Indexing Active investing
Less transactions as it uses a ‘buy and hold’ strategy. This means lower transaction costs and less tax to pay. Actively buying and selling stocks, which means increased transaction costs and potentially more tax to pay in a given year.
Results aim to achieve the market return every year. Results are variable – some fund managers might outperform the market in a given year, many don’t. Even fewer can consistently outperform the market.
Risks may be reduced as your money is spread across different market sectors. Potentially riskier if your money is invested heavily in fewer market sectors or securities.
Lower fees paid to fund managers. Higher fees paid to fund managers.

 

* Source: Vanguard: “Understanding Indexing”
** Source: By FUM, Rainmaker and Vanguard