Indexing
Introduction to indexing
What is indexing?
Indexing is a way of gaining exposure to an investment market. Most investment markets have indexes that measure their value over time. Indexes cover almost every industry sector and asset class, including Australian and international shares, property, bonds and cash.
How is indexing different to active management?
Active fund managers try to outperform the index by picking sectors and securities they believe will outperform in the future.
Rather than trying to guess which investments will outperform in the future, index managers replicate a particular market or sector. This means they invest in all or most of the securities in the index.
Indexing is based on the theory that investors as a group cannot beat the market - because they are the market. In fact, when you take costs into account Vanguard founder John C Bogle says investors as a group must underperform the market.
This is why when you look at the performance tables at any point in time there are always winners and losers. Picking consistent outperformers is almost impossible, so indexing provides a way of accessing market performance without the high costs.
What are the benefits of indexing?
Indexing offers two distinct advantages:
- Investing in all or a representation of stocks in a market index can maximise diversification and reduce risk.
- Buying and holding securities over the long term reduces volatility and investment costs (including tax) and can lead to better returns in the long run.
Types of index funds
Here are some of the more popular types of index funds available today.
- Full replication - invests in all securities in an index
- Partial replication - holds a representative sample of securities in an index
- Exchange Traded Funds - managed funds traded on the stock exchange like shares
- Enhanced index funds - index funds offering enhanced performance
