1. Decide on an index fund investment strategy
An index fund’s investment strategy considers overall financial goals, risk tolerance and timelines.
If you are working with a financial advisor, they can help you determine the best combination of funds for your situation. When you open an account with a robo-advisor, an algorithm will suggest a strategy based on your answers to the account opening questions.
When choosing your own index fund allocation, it’s important to keep in mind how ambitious you are, your risk tolerance, and your investment timeframe. In Australia most people invest in index funds via his ETFs and these are excellent long term investments but investors should not expect to make money quickly.
Advisors generally recommend holding more equities and less fixed income products such as bonds in your portfolio if you are far from your goals. As you get closer to your goals, gradually adjust your mix away from equities and into lower risk investments such as bonds.
How aggressive you are will depend on how much risk you are willing to take, as reflected in the ratio of equity index funds to bond index funds. For short-term goals of three years or less, you may be better off with a high-interest savings account or term deposit. Consider all options and choose the path that is right for you.
2. Research index funds
Research is important because it’s important to know what you’re getting with an index fund.
First, select one or more indexes. The ASX200 is probably Australia’s best-known index, but there are also indices based on market opportunities such as company size, business sector and emerging markets. You can choose a commodity index fund that tracks currencies or commodity prices, or mid-cap US equities via iShares.
Stock indices are generally good for adding growth potential (and risk) to a portfolio. In general, the more niche the stock index, the greater the risk. Generally speaking, bond-based indices add stability to investment portfolios and offer more modest returns.
Here’s the index to start your search:
- A stock index that groups companies by size, such as the ASX200. In general, the smaller the companies included in the index, the higher the risk and growth potential.
- An index that provides exposure to the stocks of companies outside Australia, such as the S&P 500, which tracks the top 500 countries by market capitalization in the United States.
- Indices based on bonds and bond markets. These can be municipal or international bonds, as well as government and corporate bonds.
- Funds based on specific sectors such as healthcare, IT, mining and banking.
Once you’ve settled on one or more indices, you’re ready to explore individual funds. Keep the following points in mind when comparing index funds:
- administration fee. This is the cost of managing the fund each year. While most passive ETF funds have a management fee of just 0.03%, actively managed funds can track his 0.2% or higher management fee.
- Other charges. You can usually avoid index fund trading fees at most major brokerages, but when buying or selling specific funds, be aware of the loads or special fees charged by certain funds. For example, some stock trading platforms charge an inactivity fee after a certain period of time.
- Minimum amount of investment. If you don’t have enough cash to meet the minimum investment required, you can delist the fund. If you really want to buy that particular index, you’ll need to look for the Exchange Traded Fund (ETF) version of that fund. The fund generally has no minimum price above the price of one share.
Index funds that track the same index of different companies effectively have the same holdings, so cost should be a primary consideration.
3. Buy index funds
Once you open a brokerage account, you can buy stocks in a closed index fund. You can also go through a full-service broker, but be aware of the fees. Alternatively, you can go through stock trading platforms.
Typically, you search or enter the ticker symbol of the fund you want to buy and the amount you want to invest.
You have to choose either a market order or a limit order. The former buys units at the current rate, while the latter can set a specific price to avoid buying during periods of unexpected volatility.
You must purchase enough to reach the fund’s minimum investment, but after that you can generally purchase fractional shares. This site may ask whether dividends will be used to purchase additional fund shares or be credited as cash to your account.
When reinvesting for the long term, most experts recommend reinvesting your dividends.
4. Set up a purchase plan
Since investments are typically continuous, you should take the time to think about your plan for buying an index fund. Financial advisors often recommend dollar cost averaging.
To achieve this, use your brokerage firm or stock trading platform to set up automated investments that occur on a schedule (such as once a month or every payday). This ensures that you continue to invest on a regular schedule.
Investing in general is a long-term game. The stock market has its short-term ups and downs, but throughout your investment life, buying and holding a diverse mix of investments has yielded historically successful returns.
For best results, review your portfolio every 6-12 months and rebalance if your investments have deviated significantly from your original allocation. To rebalance, sell some of the overgrown categories and buy more of the undergrown categories. This will help you keep your portfolio on track and reach your goals.
5. Decide on an exit strategy
Buying and holding is a solid investment strategy, but you should also consider when and how you sell stocks.
A financial advisor or tax professional can help you find the best strategy for managing withdrawals from any type of investment account and explain tax implications, including capital gains tax. In Australia, if the shares have been owned by him for 12 months or more, he may be eligible for a 50% capital gains tax discount.