If you are distressed with high fees but not so high returns from active fund managers then take a look at Index Funds…They don’t necessarily have to replace all your active funds in your portfolio instead they can make a good addition to your existing portfolio. Lets find out more about these funds:

What Are Index Funds

The index fund attempts to copy the performance of an index. For example - Equity Index Fund in Australia might attempt to copy the performance of ASX All Ordinaries Index. A Bond Index fund might attempt to copy the performance of UBC Composite Bond Index.

So basically the fund attempts to perform in line with the market index for that sector by creating a portfolio that mirrors the market index.

A passive style of investing is where you are not trying to outperform the market. You take a ’sit back and forget’ style of approach. Index Funds use a passive investment style.

All the assets held in the index fund have the same percentage holding as the index they are trying to follow. For example - Consider an Equity Index Fund following ASX All Ords Index. As weights of companies in All Ords changes, the index funds add or dispose of part of their holdings…Similarly when new companies are added to the index, new companies are added to the index fund. However the frequency of buying and selling of assets in an index fund is much much less than that in an active fund.

Sometimes it is incorrectly assumed that the index funds have no risk. Whilst it might not have as much risk as an active fund, it still has the market risk. In a bull market the index funds do well. And in a bear market they fall in value…So basically Index funds cannot protect you in a market downturn (unlike active funds which try to beat the market performance - be it bull or bear). Over long term though the index funds perform quite well.

Share Index funds are best suited for a long term investment time frame. They also can make a good addition to a DIY super fund. Their approach of ‘Buy And Hold’ plus a broad diversification is well suited for a DIY super fund…

What Are The Advantages

Here is a list of the main advantages of an index fund…

Cost Factor: You are not actively trying to beat the market…You are just trying to copy the market…And so the investment management costs of an index fund is much lower than that of an index fund…The MER for an index fund is usually between .75% and 1% (much less than the 2 to 2.5% of an active fund).

Broad Diversification: The index funds invest in all assets included in the index…And hence they are very broadly diversified. The risk of low return through one or two stocks is greatly reduced.

Performance This is a bit of controversial topic…But nevertheless it has to be said - It is not easy to consistently outperform the market…A lot of active fund managers try but only a few succeed….But the reality is all active fund managers charge high fees because they are by nature ‘active’ and hence have higher costs. Index funds on the other hand have shown that over a long period they consistently perform well…..They seem to deliver what they are aiming for…And some times over a long term they even outperform some active funds.

Who Are The Players And What Are The Common Funds

Vanguard Fund Managers is one of the most well known players in the index funds industry…They have a wide range of funds on offer…AMP and Barclays also offer index funds.

If there is a market index for a sector then you usually have an index fund for that sector…Example - Australian Shares, Listed Property Trusts, Fixed Income, Small Caps, International Shares, Cash Funds etc…

What About Enhanced Index Funds

Some fund managers (like Macquarie) offer Enhanced Index Funds. The aim of these funds is to marginally outperform the index…The MER of these funds are slightly higher than normal index funds and is usually between 1 and 2%.

I personally haven’t got any investments in index funds…But am keen to look further into some of the offers (particularly the enhanced funds). What about you? What are your thoughts about these funds?

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