Five Tips For Choosing The Right Index Fund Amid The Passive Investing Craze

Wednesday, 28 July 2021, 6:04 pm
Press Release: Kalkine

Summary

• Passive investing has gained considerable attention in the COVID-19 era, with NZ markets resonating with this interesting trend.
• Unlike active funds, passive funds do not involve active management but rely on an underlying benchmark index.
• Before taking the plunge in passive funds, investors should consider certain aspects, such as associated costs, personal needs, risk profile, and the fund’s track record.

The pandemic has brought some radical changes in investment strategies that are likely to shape future trends in the financial market. Passive investing has been one such vehicle of change for which investors across the globe are vouching. Unlike active investing, passive investing involves investing in Exchange Traded Funds (ETFs) or index funds for the long term instead of trading for a shorter horizon.

Throughout the virus crisis, investments in ETFs and index-based funds outperformed the investments in actively managed funds.

Interestingly, the NZ markets have also resonated with this trend. A larger share of investments has poured in the passively managed funds in the COVID-19 era. Moreover, the trend has struck the pleasant chord of the world’s most renowned investor Warren Buffet who has long advocated passive funds despite being known as a value investing beacon.

At a time when index funds continue to increase in popularity across the financial market, investors should remember that choosing a passive fund is not a straightforward task. Besides, with hundreds of index funds trading in the market, selecting the right passive fund can be daunting.

Having said that, investors can follow the below tips and strategies to choose the right index fund and beat passive funds’ active rivals on both the performance and price front:

Choose Index that Best Matches Your Diversification Needs

While numerous benchmark indices are available in the market, investors should pick an index that brings in more variety to the portfolio and minimises risk.

For those interested in maintaining a relatively low-risk portfolio, tracking well-known indexes such as NZX 50, ASX 200, or S&P 500 is a viable option. However, if an investor wishes to go beyond these renowned indexes, the ideal approach is choosing the preferred company size. For instance, some indices track the largest companies on the NZX, while others focus on smaller growth companies.

In fact, certain indices also track investments based out of a particular domain, like technology, property, or bonds. Thus, investors can also look for a sector or industry that seems particularly appealing to them while choosing the index.

Pay Heed to Costs

Index funds are not actively managed by a group of well-paid analysts and are considered cost-effective. However, they do carry some administrative costs. Investors willing to maximise returns over the long run can embrace the index fund with lower expense ratios, loads, and management fees to reduce the cost burden.

The associated costs may include the membership fee of the intermediary platform or the management fee of the investment managers. A thorough investigation into the fund would provide the investor with cost estimates to help him pick out the fund with the highest net returns.

Look for any Investment Minimums

Apart from the costs mentioned above, index funds might require a minimum investment amount to be put in. For instance, some index funds may ask for a few thousand dollars as a prerequisite to investing with them. It is crucial for investors to look for these investment minimums in advance and see if they can meet the same.

Investors should understand that a fund with a higher minimum investment might not necessarily be offering greater returns. Besides, novice investors willing to try out their hands on the index funds can take exposure in funds with a lower investment minimum to minimise potential losses.

Know Your Risk Profile

Investors should understand that index funds are not fundamentally less risky than active funds. Thus, investors should closely assess how much risk they are willing to take and decide their asset allocation accordingly.

A good starting point is to analyse one’s financial obligations and map out upcoming major expenditures. As individuals can have a different set of goals based on their age and financial constraints, the above criterion is subject to change. Simply put, investors can get some leeway when they are not carrying any obligations, and they might be open to high-risk opportunities.

Check if the Index Fund is Doing its Job

Most funds provide detailed information about their operations and maintain a high level of transparency about their returns. Investors may use this information to their advantage by monitoring the invested amount and the subsequent returns offered on it.

Additionally, investors should check whether the index fund is closely tracking the performance of the index. To do so, investors can review index fund’s returns during different time periods and compare them with the benchmark index’s performance.

All in all, passive investing is a trend that holds decent potential in the post-Covid recovery scenario. Investors planning to jump on the bandwagon should evaluate index funds based on various quantitative and qualitative parameters to make the best out of passive investing.

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