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How to invest in index funds

The ins and outs of bundling stocks with this accessible investing option.

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An index fund is typically a low-cost, low-risk investment portfolio of stocks and other assets that tracks a financial market index.

They’re popular because they’re generally easy to trade and many don’t require a big investment. But it’s not guaranteed that all the funds in the index are safe — there’s still risk of volatility.

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How to start investing in index funds

Once you’re ready to invest in index funds, use a financial adviser, robo-advisor, full-service broker or online stock trading platform. One of the most accessible ways to start investing in index funds is with exchange traded funds (ETFs) — but not all ETFs are index funds and some are riskier than others.

Mutual funds are another index fund and can be purchased directly through their associated fund providers, such as Allan Gray, ABSA, Investec, and Coronation Fund Managers.

To invest in ETFs or unlisted mutual funds:

1. Consider your strategy

Ask yourself what you want to achieve through this investment. Consider your timeframe and how much risk you’re willing to take on. Will you need to withdraw the funds in a year, or do you plan top sit on them 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 costs.

Key things to take into account when deciding on an index fund:

  • Management
  • Brokerage fees
  • Transaction fees
  • Its performance over the last 3, 5 and 10 years
  • Volatility
  • Minimum investment amount
  • How often you plan to transact with the fund

3. Sign up through a fund manager or online account

Once you’ve found the right product, find out the best way to access funds.

Access index funds through their fund providers.

  • When applying directly to a fund manager, fill out an application, provide proof of address and ID. Fund with a proof of transaction.
  • Financial planners can also apply for an index fund on your behalf.

Access ETFs on most online trading platforms and purchase just like any other stock. Sign up for an online stock trading platform:

  • 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

What are index funds?

Index funds pool money from multiple investors to diversify your portfolio. They generally take a hands-off approach to investing compared to managed funds.

Because index funds don’t require active management, they tend to cost less than managed funds, and don’t cost as much to invest in.

What is a stock market index?

To understand an index fund, it’s important to know what an index is. A market index helps you understand index funds. The most well-known index is the S&P 500, which is a collection of the top 500 companies in the US stock market.

These indices are popular 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 the same selection of stocks that make up the index they follow. Here are a few examples of index funds and their underlying index:

  • SPY — S&P 500 index
  • QQQ — NASDAQ 100 index
  • AGG — Bloomberg Barclays U.S. Aggregate Index (bonds)
  • VEA — FTSE Developed All Cap ex US Index
  • FTSE/JSE Top 40 — FTSE/JSE Top 40 Index
  • ALSI — JSE All Share index

If a company leaves an index, the fund manager sells its shares and replaces it with new stocks. Because these kinds of funds require minimal management, it’s known as passive investing. Index funds can be either ETFs or mutual funds.

The difference between index ETFs and traditional index mutual funds

Most ETFs are similar to traditional index mutual funds in that they are low cost and track a major underlying index, though there are a few key differences:

Trade and listingPricingWhen to buy and sellMinimum investmentFees
ETFsTraded like shares on the stock exchangeMarket value, depends on stock market performanceAny time during the trading dayLower minimum — sometimes under R1000
  • Commission on some brokerages
  • Lower taxation and management fees
Mutual fundsUnlisted and bought from issuerNet asset value of underlying securities.At the end of the trading dayCan require as much as R2,500 or more
  • No transaction fees
  • Some charge load fees

What are the benefits of investing in an index fund?

A few bright spots for index funds:

  • Cost. Passive funds require less legwork, so they typically come with less fees than funds that an advisor manages. Fees can eat into any gains in returns.
  • Higher returns. Indices have frequently beat the average returns of managed funds.
  • Easy to trade. Access multiple options for index fund ETFs on brokerage platforms.
  • Diversifies your portfolio. Investing in an index fund offers access to a range of companies from various industries.
  • Less volatile. A safer alternative to individual direct stock market investing.

What are the risks of index funds?

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:

  • Potential to lose 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.
  • Not all assets are safe. Do your research and find out which index funds track volatile markets — like oil. Others bundle in leveraged and inverse ETFs. 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, especially leveraged and inverse ETFs.
  • 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.
Disclaimer: The value of any investment can go up or down depending on news, trends and market conditions. We are not investment advisers, so do your own due diligence to understand the risks before you invest.

Bottom line

Index funds are well-diversified, accessible investments, making them a popular choice for new investors. But there are also more complex and risky ETFs thrown into the mix of most mainstream brokerage accounts. It pays to familiarize yourself with their benefits and dangers, and to compare brokerage accounts before putting your money to work in the stock market.

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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