Index Fund, Easy to understand, Low investment but long-term interest

In the shareholder meeting of Berkshire Hathaway company in 2004, Warren Buffett, the CEO answered the question from one of the stakeholders that “If you average your investment in any low capital cost index fund for at least 10 years is better than investing a one-time large amount of money also you will get a higher profit than other investors that invest in other properties at the same time period”  

Buffett explained that “If you could spend at least 6 - 8 hours a week for studying about the investment, then you can invest by yourself. However, if you do not have time, you should invest and accumulate in index fund periodically which has a low risk both in money and time. And that 2 things are an important thing for investment.”

The Index Fund is a fund that has a passive management strategy which invests in the index securities by imitating to get the same return as the Benchmark index. 

Most of Thai Index Funds are investing in a stock index such as SET50 Index, SET100 Index or particular segment index such as energy, commercial bank, etc. For the international market, they invest in Bond Index or other properties.

Investing method of an Index fund is the fund manager will allocate the investment regarding the reference index. For example, if the Index fund reference is the SET50 Index, the fund will invest in the largest 50 stock in the market cap of the Thai market. If the fund reference is the SET100 Index, it will invest in the largest 100. However, if its reference is energy index, this means the fund will invest in all energy index. 

This investment type will create almost the same return as the reference index. For example, if the return of the reference index is 10% of the net asset value (NAV), then those index fund will increase 10% as same as the return index. On the other hand, if the return of the reference index decreases, the NAV of that index fund also decreases at the same rate.       

To identify whether which fund is an index fund, it can be seen that the fund will be named as the reference one such as SCB SET50 Index Fund which is the index fund that refers with SET50 Index, or the SCB SET Banking Sector Index which refers with banking index.

Moreover, you can find more detail in the prospectus booklet which shows the index type, or you can check the asset management website which shows each fund category and detail. The index fund is one of that. 

What is the benefit of the Index Fund?

From the Securities and Exchange Commission (SEC) information says that the risk in investing in the index fund is based on the index selection which targets in the return of index fund. Therefore, the return will be in the same direction and will not win their reference index return. This is the same strategy with the active management investment. Information on proactive or reactive strategy will be shown in the prospectus booklet. 

So, the index fund risk is lower than another fund type. Its risk only comes from the instability of the index and not from a mistake of the management team. For example, investing in the index that did not give an expected result because when investing in the target index, the return will be the same as the reference index.

Hence, the index fund is suited for any beginner investor who wants to invest in the equity fund but does not have enough knowledge about the equity fund policy and their wants.

Moreover, the index fund is suited for any long-term investor who plans for retirement and can save money by the Dollar Cost Averaging (DCA) because these indexes are suited for a long-term investment such as 10 or 20 years. The longer you invest, the less risk you receive with a higher return.

From the latest information (31 January 2019), the SET50 Total Return average or the SET50 TRI from 2009 - 2018 (10 years) is 17.77% per year. So, the index fund which refers with SET50 Index will receive the same return.

How to choose?

Due to the index fund is based on their reference index so it has simple management with a smaller number of a fund manager and analysis for index selection to get a high return. Therefore, the management and other fees are low compared to other funds.

So, choosing an index fund, you should consider the management and other fees which should be low.

You can find the fee details in the prospectus booklet and Fact Sheet of each fund and you should consider 4 topics which are as below

  1. Total Expense Ratio is a fund operating costs such as management fees, trustee fees, registrar fees, and analysis fees. You should find a low total fee compare to others.

  2. Initial Charge. Some index fund has, and some has not. Do not forget to consider this.

  3. Tracking Difference (Reference Index). You should find the index fund with the same return as the reference index such as the SET50 Index return since 2009 - 2018 (10 years) equal to 17.77% per year, then the index fund return should be the same.

  4. Tracking Error is a tool to identify how similar the index fund can be compared to the reference index. Investors should choose the low tracking error number fund which means the fund is almost the same as the reference index.

However, the index fund maybe not suited with a high-experienced index investor or anyone who interest in the fund with talented management for index selection. Due to the index fund, investors cannot choose the index for their port and have to accept all reference index and they may not like them all.

Therefore, before deciding to invest in the index fund, you should ask yourself some questions about whether are you suited with this fund type? How long you want to invest? and do you have enough money to invest as DCA? Because the achievement and sustainability of the investment are based on a good start and your right choice.