Index Funds Experiment
For the last year, I have conducted an experiment in investing in Index Funds. Over the year I have invested $10,000 in about 570 different companies in New Zealand, Australia, and the United States. Our investment has returned $85.00 of dividends (that’s 19 free coffees a year millennials) and increased approximately 8% in value.
It’s a small start towards financial independence, but an important one. Let me explain why we chose to invest in index funds and how our experience has been.
Like most people, I grew up thinking that investing in the share market was basically gambling with your money. Or, you had to dedicate your life to studying dense financial statements with a calculator permanently stuck to your hand. Failing that, you had to trust your money to a dodgy financial company that would charge you truckload regardless of if they made you money or not.
What are Index Funds?
I stayed away from shares for a long time until a couple of years ago I discovered something called index funds. Index funds are a type of fund that invests their money into a predetermined list of companies called an index (duh). You may have heard of the Dow Jones Index in the business section of the evening news (who am I kidding, no one watches the news anymore).
There are many indexes around the world but a few stick out. In New Zealand, the major index is the NZX 50. You would recognise many of the names in the NZX 50; Air New Zealand, Spark, Westpac all feature.
In the United States the S&P500 is another mainstay. These indexes contain the biggest companies in their countries.
Its only been in the last couple of years that index funds have really started to gain awareness in New Zealand, although they have been very popular in the United States for some years.
Why Invest in Index Funds?
What an index fund allows me to do is invest a small amount in all the companies in the index. This means if one company goes bankrupt and I lose my money, I have only lost a small proportion of my total investment. For example, a $1 dollar investment in the NZX 50 might buy 5c worth of shares of Auckland International Airport, Fisher and Paykel Healthcare, and Contact Energy each (among 47 others of course). If a freak storm washes out the Auckland Airport and the stock price plummets 40% over night, I have only lost 2 cents.
Essentially, what an index fund allows you to do is get the average of what the market is doing. Yeah sure, I’m not going to double my money in six weeks, but I’m not going to lose it all (unless the largest 50 companies in New Zealand collectively go bust! In that case, I think we have much bigger problems than the price of shares)
I had two main requirements for investing in the share market:
Diversification – I didn’t want to risk buying the wrong stock and losing 90% in the next crash. I’m not an expert on the share market and I don’t want to dedicate my life to becoming a professional investor.
Drip feeding – I wanted to invest via direct debit monthly. Saving is so much easier if it happens without you have to physically do anything. As well, by purchasing every monthly we make sure that we aren’t buying at the peak of the market (because we are buying every peak and trough of the market). This is called dollar cost averaging. By buying shares on the way up as well as the way down we ensure that we aren’t buying high and sell low.
Dollar–cost averaging (DCA) is an investment technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. – http://www.investopedia.com/terms/d/dollarcostaveraging.asp
Apart from paying extra off our mortgage, this is the main source of investing we are actively pursuing. At the moment about 80% of our net worth is in property. Ideally, for the sake of diversification, I would like to see our index investments increase to 20%.
Who we chose to invest with for Index Funds
The main companies I found that offered index funds were SuperLife, Smartshares – although I have noticed in the last week a couple of new providers have emerged (Simplicity and Investnow.co.nz).
I chose SmartShares because for the amount we wanted to invest they had the lowest fees. They also seemed the most reputable, having been around for a long time, and had a clear and easy to understand website.
After a lengthy application (which you can do online now) we was enrolled in our first index fund; the S&P 500.
You have to start with a $500 deposit, minus a $30 fee and for direct debit, a minimum of $50 a month. The $30 seems small but acts as a 6% fee on the initial $500.00.
I have since added the NZX 50 index fund, as well as the ASX20. Initially, I started off with only contributing $50 a month, but have since increased that to $500 per fund.
First Year Experiment Results
The following graphs should how much it has cost us to buy (dollar cost average) vs the value of each unit in the index fund. Essentially, when the green line is above the blue line our investments are worth more than what they cost us to buy.
Amount Invested $3,500.00
Current Value $3,836.24 (+$335.24)
Amount Invested $3,300.00
Current Value $3,412.91 (+$112.91)
Amount Invested $3,200.00
Current Value $3,558.75 (+$358.75)
Overall, we have been very happy with our investing experiment. The $30 per fund initial setup fee is surprisingly obvious in the graphs but as we invested more its impact swiftly diminished.
As I suspected, my ability to guess what the market would do was completely wrong, so I am glad we invested every month regardless of what the market was doing. I especially did not predict the market resurgence following Trump’s election!
If I could do this all over again, I would have started direct debiting a higher amount than $50.00. Unfortunately, my lack of experience at the time meant that I needed to start small.
While the index funds investment has increased in value by approximately 8% its important to be aware that the markets ebb and flow. I don’t expect every year to return 8%, but it has been nice to have a positive start.
What was much cooler was seeing the increase from dividends. Receiving the first letter explaining that our $0.54 dividend had been reinvested was a tad disappointing I will admit. However, it was very cool getting paid just for the privilege of owning shares.
Lastly, without the direct debit option I do not think we would have been able to invest as much as we did. I will explain in the next section.
Pay yourself first
If you have spent anytime googling how to budget, save, or get rich it is likely that you will come across the same advice – pay yourself first.
I always thought this was stupid advice – like I’m going to pay someone else first. But the advice is solid, put money away for YOUR goals first, before spending it elsewhere.
To be able to do this you need to have money available – if you don’t, then you need to work on reducing your spending or earning more.
By contributing via direct debit every month an amount that is a stretch, but doable, we were able to invest $10,000 (as well as reinvest $85 of dividends). Even as disciplined as we are, I am not sure we would have saved that much on our own.
Psychologically, I find that it is easier to save and invest if the process is automated. Then you don’t have to go through the whole decision-making process and feeling of sacrifice each time you invest.
Where to from here
I want to continue investing $500 a month in each index fund, increasing that as much is comfortably possible. As mentioned above, we are aiming to get our percentage of net worth invested in index funds to 20% (currently sitting closer to 4%).
Most information online is from an American perspective. So I’m interested to know how others have found investing in index funds in New Zealand.
Let me know who you invest with and how you have found the experience in the comment section below.