Have you ever thought about investing in shares, but don’t know where to start?
If you’ve put it off because you’ve found the terminology intimidating, you’re not alone. It can feel like a foreign language when you first start, but I promise it’s much less scary than it looks when you get into it.
When it comes to acronyms about shares, I have a favourite: ETF, which stands for exchange traded fund. They’re part of a group known as index funds.
What does an index fund do?
With so much uncertainty in the world, it’s hard to reliably predict what a single company — or even a single industry — will do over the long term.
To combat uncertainty, the popular advice is to diversify — to hold investments across many asset types, industries, and countries. That way, when some do poorly, others balance them out.
It’s an attempt to smooth performance, and while it’s no guarantee of success, it can reduce risk and improve your chances of a good outcome.
It used to be hard to build a diversified portfolio on a small budget, since you don’t always have enough money to buy the minimum per-share amount for lots of companies ($A500 worth on the Australian Securities Exchange, ASX).
But it’s much easier now with index funds like ETFs, which are a shortcut to diversification.
Index funds buy a range of investments, then you buy shares in the index fund. A single share in an index fund represents indirect ownership of all the shares it holds, so you’re getting diversification that way.
There are index funds for all sorts of asset groupings. For example, they might invest in the ASX200 — the 200 biggest companies on the ASX.
Buying a fund like this is like voting for the share market to go up, rather than any single company or industry, since the fund buys and sells companies as they enter or leave the index. It’s self-correcting.
Other index funds hold gold mining companies, cryptocurrency, the top 10,000 companies globally, or bonds and commodities.
There’s a plethora to choose from, so it’s important to carefully consider which ones you buy, including:
1. What they invest in
Every dollar you invest is a vote for the future you want. Once you own a share in a fund, you’re supporting all the assets it holds on your behalf.
There’s a plethora of index funds to choose from, so it’s important to carefully consider which ones you buy. (Adobe Stock)
If you’re worried about AI, you might not want a fund holding companies involved in it. If you’re worried about environmental damage, you might not want one holding fossil fuel producers.
ETFs publish complete holdings lists on their websites, so you can go straight to the source to see what each ETF holds.
Overseas investments can mean slightly more complicated tax affairs, so keep that in mind if you value simplicity.
2. Their fees
Index funds charge shareholders a fee for managing the fund.
Just like fees in superannuation, it effectively comes out of your investment. You can check what fees your index fund is charging and whether another fund is doing the same investment strategy for lower fees elsewhere.
3. Your goals
As with any listed share, index funds can help shareholders build wealth in two ways:
• Growth, as the value of the underlying investments goes up.
• Income, as the shareholders get some of the profits as dividends.
You can get both growth and income in a single index fund, but some focus more heavily on one over the other.
If your goal is to hold the shares forever and use the income for your living costs, check your chosen index fund pays reasonable dividends before you buy.
4. Other types of index funds
If you’re keen on ETFs, it’s worth checking out their brethren. I particularly like listed investment companies (LICs). ETFs get the most press, but LICs do the same job through a different structure.
ETFs use a trust structure, forcing them to pass income on to shareholders. All assets in the ETF must be sold when the trust expires, so shareholders can have a forced capital gain event if the trust wraps up — a rare but annoying occurrence for investors who wanted to hold their shares forever.
LICs use a company structure, so they decide how much income to pass on to shareholders. Assets don’t have to be sold if the LIC’s ownership changes, so capital gains events aren’t forced (although this can still happen).
As with all investing, index funds come with risk. Their prices can and do go down, so it’s best not to use money you can’t afford to lose, or will need to access soon.
Moneysmart and ASX have excellent resources to help you learn more about investing before leaping in (note ASX makes money from share trading, so it has a vested interest in your decisions.).
You can also consult a licensed financial adviser to work out if index funds are a good fit for your personal situation before buying, including an ethical adviser if you want to make sure you’re not accidentally supporting companies or industries you don’t want to.
Lacey Filipich is a financial educator and the author of Money School.
This article contains general information only. You should consider obtaining independent professional advice in relation to your particular circumstances.