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How to invest in index funds in New Zealand
Get access to a bundle of stocks through a low-cost index fund by following our beginner's guide.
If you’re looking to invest, you may have heard about index funds from financial experts, or even the esteemed Warren Buffet. There’s a good reason they’re so well-regarded. An index fund is typically a low-cost, low-risk investment portfolio of shares and other assets that tracks a financial market index.
But how do they work and what makes them different to other kinds of funds? This guide cuts through the financial jargon to cover everything you need to know about index funds in New Zealand and why they’re creating so much buzz.
What's in this guide?
How to start investing
If you already understand what index funds are and want to start investing, you can do so through a fund manager, a full service broker or an online share trading platform. One of the easiest and cheapest ways to access index funds is via exchange traded funds (ETFs) which are traded on an exchange such as the New Zealand Stock Exchange (NZX), the New York Stock Exchange (NYSE) and so on.
Before you do so, you should know that not all ETFs are index funds and some funds are riskier than others – you can read more about this below.
You also have the option of investing in an Index CFDs. A CFD is a contract between a buyer and a seller, where one agrees to pay the other the price difference between the opening and closing price of the contract.
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What are index funds?
A typical managed investment fund is a portfolio of stocks and other assets. Instead of buying shares in one company, you can invest in a bundle of them. To deliver profits for their clients, fund managers buy and sell assets within the fund by trying to predict market movements. This difficult feat is known as “active” management.
An index fund is handled a little differently. It’s simply a pool of company stocks that mimics a financial index, requiring little intervention from its fund managers.
What is a stock market index?
To understand an index fund, it’s important to know what an index is. A market index is normally a collection of stocks that are listed on a stock exchange. New Zealand’s most well-known index is the NZX 50, which consists of New Zealand’s largest 50 companies by market capitalisation. The Wall Street alternative is the S&P 500 index, which includes the top 500 listed companies in the US.
You’ll notice these indices are frequently cited in the media because investors use them to track the overall performance of a market. They rise and fall depending on a range of economic indicators and company news. For example, when an economy is healthy, its stock market indices tend to rise because investors feel more confident buying stocks. If trade tensions increase between countries, stock market indices usually fall as investors become nervous.
How do index funds work?
Index funds hold a selection of stocks that make up an index. If a company leaves an index, the fund manager simply sells its shares and replaces it with new stocks. For this reason, index funds are considered a comparatively safe, albeit less exciting, alternative to directly buying shares in a company. Because these kinds of funds require minimal management, it’s known as “passive” investing.
It’s important to note that while index funds are sometimes ‘mutual funds’ overseas, within New Zealand, the term “index fund” more often refers to exchange-traded funds (ETFs).
What is an ETF?
An ETF is a basket of securities that’s listed on a stock market, such as the NZX. In New Zealand, ETFs are typically “passive” investments that track an asset or index, but this isn’t always the case. You can read more about these funds in our informational ETF guide.Confused about the terminology? You’re not alone. These terms are changing all the time and vary across different borders. Despite the popularity of traditional managed (sometimes called mutual) index funds in the US and other countries, there are fewer such options available in New Zealand. Instead, many New Zealand investors use ETFs to track indices as they work in much the same way but are broadly easier to access and have a lower minimum cost requirement.
The difference between ETFs and traditional index funds
Most ETFs are similar to traditional index funds in that they are low-cost and track a major underlying index, though there are a few key differences:
- ETFs are listed. The main difference is that ETFs are traded like shares on the stock exchange while index funds are unlisted managed funds.
- They’re priced differently. The price that you pay for an ETF is its market value depending on its performance on the stock market. The price that you might buy or sell into an index fund is the net asset value of its underlying securities.
- Buying and selling. ETFs can be bought or sold at any time during a trading day, whereas managed funds are only priced at the end of the day.
- ETFs have lower minimum investment. Index funds typically require a higher minimum investment of more than $5,000. Many ETFs can be purchased for less than $100.
- Index funds don’t charge a transaction fee. There’s almost always a brokerage fee involved when buying or selling an ETF, but index funds tend to skip this cost. This means that a managed index fund can be a good option for investors looking to frequently add small amounts to their fund over time.
- ETFs have lower fees. On the other hand, taxation and management fees tend to be lower for ETFs than traditional index funds.
Why invest in an index fund?
Simply put, index funds have been proven to outperform many other kinds of investments.
In 2007, one of the world’s most successful investors, Warren Buffet, made a $1 million bet that a bundle of active managed funds would be worse off than the S&P 500 over 10 years. He argued that if a fund simply mimicked a major index, it would deliver better returns than a fund actively managed by professionals. A decade later, Buffet won that bet.
The point is that, although major indices fluctuate from year to year, they usually rise over a long period of time. For example, the NZX 50 index fell by more than 4.7% during the 2008 global financial crisis. But even if you had invested in the index fund just prior to that, you’d still be in a better financial position today than if you’d not invested at all.
What are the benefits of investing in an index fund?
- Index funds cost less. Passive funds require less legwork, so they typically charge lower fees than actively managed funds. In managed funds, high fees can easily eat into any returns gained by the broker.
- They can achieve higher returns. Indices have been proven to frequently beat the average returns achieved by fund managers over many years. Coupled with lower fees they make good investing sense.
- Ease of trade. Many ETFs listed on the NZX are index funds, which are easily accessible on broking platforms.
- It can diversify your portfolio. Investing in an index fund offers access to a range of companies from various sectors.
- They’re relatively safe. Index funds are considered a safer alternative to direct stock market investing because indices are generally less volatile than individual stocks.
Of course, no investment is ever 100% “safe” and you should always seek professional advice before making any investment decision. Here are some of the risks that investors need to be aware of:
What are the risks of index funds?
- You could lose your money. Like any investment, you take the bad with the good. When an index does well, your investment delivers profitable returns, but when an index drops, so does your investment.
- It’s not a short-term plan. Passive funds perform best over many years. If you invest in an index fund but find you need the money six months later, there’s a good chance you’ll have less than you started with.
- Not all assets are safe. Although many index funds track relatively safe major indices, technically any pool of assets can be bundled into a fund. Some index funds track volatile global markets, such as the oil sector, while others bundle in riskier investment assets. Always do your homework.
- Not all ETFs are index funds. ETFs come in all shapes and sizes and not all are passively managed. Some are highly complex and risky. You can read more about different kinds of ETFs here.
Popular index funds and ETFs available in New Zealand
| NAME | INDEX |
|---|---|
| Vanguard International Shares Select Exclusions Index Fund | MSCI World ex Australia, ex Tobacco, ex Controversial Weapons, ex Nuclear Weapons |
| NZ Top 50 ETF | S&P/NZX 50 |
| US 500 ETF | S&P 500 Index |
| Smartshares S&P/ASX 200 ETF | S&P/ASX 200 |
Steps to invest an index fund
Most major fund managers offer access to a limited pool of index funds, though ETFs are the more readily accessible option within New Zealand.
Traditional index funds can be purchased directly through their associated fund providers, ETFs can be purchased with any regular stockbroking account.
Whether you want to invest in an ETF or an unlisted index fund, these are the steps you need to follow:
1. Consider your strategy
Ask yourself what you want to achieve through this investment. Consider your time frame and how much risk you’re willing to take on. Will you need to withdraw the funds in a year’s time or can they sit for 10 years?
2. Assess your options
Compare funds online to find a product that matches your goals. Consider the risks, the fund’s performance, the brokerage fees and other transaction costs.
Key things to take into account when deciding on an index fund:
- Management
- Brokerage fees
- Transaction fees
- The fund’s performance over the last 3, 5 and 10 years
- Are the fund’s assets safe or does the fund contain some volatility?
- The minimum investment amount and how often you plan to transact with the fund.
3. Sign up through a fund manager or online broker
Once you’ve found the right product, you’ll need to work out the best way to access it.
Index funds can be accessed through their fund providers:
- When applying directly to a fund manager, you’ll need to fill out an application form, provide proof of address, ID and tax file number. This will need to be posted or emailed back with a cheque or proof of transaction.
- Financial planners can also apply for an index fund on your behalf.
ETFs are accessible on most online trading platforms and can be purchased just like any other stock. You’ll need to sign up for an online share trading platform. To do this, you’ll need to:
- Provide personal details and proof of ID
- Transfer money into your trading account
- Log in to your account
- Search for the ETF you want and place a buy order.
For more information about ETFs make sure to check out our extensive guide.
Disclaimer: This information should not be interpreted as an endorsement of futures, stocks, ETFs, CFDs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for all investors. Trading CFDs and forex on leverage comes with a higher risk of losing money rapidly. Past performance is not an indication of future results. Consider your own circumstances, and obtain your own advice, before making any trades.
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