Battle of the index funds: Conclusion

Well that wraps up our 9 round battle between the index fund providers. It goes to show how each fund is unique with different cost structures. If you have multiple funds then there is no reason why you have to be loyal to one provider. Analyse each fund on its merits.

Below is a summary of the results for the lowest cost index fund providers in New Zealand:

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Update March 2019: due to the introduction of a new emerging market fund from InvestNow, they are the new ‘winner’. You can check out the findings here

Interestingly, even though Smartshares provide many of the index funds, they rarely emerge victorious on a cost basis. In fact, only once. With small investments in the Australian Resources fund.

Sharesies is no where to be seen. They tend to perform very poorly with small investing amounts because of their high $30 administration fee. I presume a lot of their investors are new investors and with low investment amounts. They could be paying over 1% in fees with this fee structure. This is not the definition of a low cost index fund. But at least Sharesies is getting people investing through easy to understand language and information.

Ironically, Sharesies funds perform much better with higher investing amounts. They are very competitive in that space.

The 4 most popular funds are the NZ50, US500, NZ Bond, and world. In terms of cost, InvestNow perform best on the global stage, and Simplicity on the local stage.

How to choose an index fund

There are a huge number of choices available and it is no wonder some people find it hard just to get started.

1/. First you need to decide how long it is before you want access to the cash. If you want it within 5 years then bonds and cash are advisable. If longer than 10 years then you can start thinking about different stock, property, and resource funds.

2/. Then understand what you are investing in. You can’t be surprised when your stock fund loses money. It happens. Try to understand this then you can get a good gauge of the level of risk you are willing to take on. If your stock value goes down 40% would you be ok with that? If you are investing for longer than 10-15 years the answer should be yes. If it isn’t then you may never be able to invest in stocks. The more you can understand about stocks losing money and market cycles, the more willing to invest you will be.

Lack of knowledge is what makes the stock market a scary place. Don’t let that be you or it could cost you hundreds of thousands. I would argue that NOT investing in the stock market is risky. It is one of the best ways to grow money and beat inflation.

3/. Once you’ve determined your timeframe and tolerance for risk, then you can start thinking about creating your portfolio and strategy. For example, I’m going to want to start drawing down on some of my investments in the next 10 years. I am currently 60% in growth assets (such as stock and property funds), and 40% in bonds. If I didn’t need the money within 10 years, then my bond allocation would be much lower. I also have a family to think about so my tolerance for risk is not that high.

Of my 60% growth assets I am allocated as below:
- 50% Smartshares total world fund
- 30% Smartshares NZ50 fund
- 5% Smartshares NZ Property fund
- 5% Smartshares Australian Property fund
- 10% Smartshares US value fund

The NZ50 and world fund make up over three quarters of my portfolio. I could be diversified enough with just these funds, but I have added the property funds and value funds as I think they are negatively correlated to my two main funds and add some further diversification to my portfolio.

Some may say that 35% is too high a percentage in my home market New Zealand. But I like the fact that the income from local stocks are almost tax free thanks to imputed dividends. You don’t get that preferential tax treatment overseas. That is a big deal for me, as reducing costs is effectively increasing money in my pocket without taking on any extra risk.

4/. Once you have decided on what type of assets you want to invest in, and in what proportions, then you can start looking at companies that offer those funds.

As you can see above, I’ve made the mistake of choosing the company first. All my funds are with Smartshares. After researching for this series though I am going to change some of my funds.

I will change my world fund to Superlife. Same fund (TWF) but lower cost. I personally like the TWF fund, so that is why I won’t be choosing to pay less for the AMP or Vanguard funds. They exclude unethical companies and i’m not willing to sacrifice performance for ethical reasons. I do enough in my everyday life to remain ethical. They also invest more heavily in the United States. With my world fund, I like the fact that it is not quite so heavily focused on one country.

With the amount I have invested I think I will move my NZ50 fund to InvestNow. Same fund for slightly lower cost. I don’t want to go to Simplicity or AMP NZ50 funds even though they cost less. I don’t like Simplcity because they have a fund manager that likes to actively manage parts of his funds. I prefer passive. I prefer Smartshares over Simplicity and AMP funds because they put a 5% cap on any one company. Meaning the fund is not too heavily reliant on the top 10 companies. This is important to me in such a small market like the NZ50. I am willing to pay a higher cost for that because it suits my investing strategy.

I will be switching my property and US funds to Superlife. Same Smartshares fund but at a lower cost than Smartshares can provide it for.

I am not telling you what I am doing so you can replicate it. You may be totally different to me and prefer a world fund with a heavy North America bias, or you may like ethical investments. Maybe you prefer funds that don’t put a 5% cap on the biggest companies. Maybe you really like the ease of us of the Sharesies platform. We are all different. I am just explaining my situation so you can see my thought process and maybe apply a similar process to your situation.

There is so much more to consider than just costs. I could have saved more by switching to the lowest cost providers such as Simplicity or Vanguard international, but those moves wouldn’t have aligned with my investment objectives and beliefs.

First decide on your investment strategy, then look at costs and other factors.

5/. Start investing. Even small amounts every month will add up over time.

6/ Rebalance. A lot of people have been riding the high of the stock markets over the last 8 years or so. When I first started investing my desired balance was 75% stocks and 25% bonds. Over the years my stock allocation had increased to almost 90% and bonds were 10%. This is due to stocks severely outperforming bonds.

Now I was taking on far more risk than I initially wanted. I wasn’t rebalancing my portfolio back to its original intention. Once I caught on to this I sold some stocks and bought some more bonds to bring it back to 75/25 and now 60/40. I plan to rebalance once per year moving forward.

7/. Review. Perform an annual review of your investment goals and portfolio. Things change that may affect our portfolio allocation. As you can see in this series, some funds suit an investor with not much money, but as your portfolio grows the fund may be one of the worst choices. Some funds may change their fees. Other funds may change their strategies. Keep an eye on these. As you age your tolerance for risk may decrease.

Run your own numbers

The data used in this series was just one set of data. I only used $600 a year for contributions to the funds. You may contribute less or more which will alter the results.

You may be able to find cheaper selling costs than the 0.3% ASB costs I was making for the Smartshare company funds. This would make Smartshares slightly more attractive than reported here. Especially in the higher value range.

You may be on a lower or higher tax bracket than was used in the world fund article.

You may be on a lower than 28% PIR tax bracket.

Returns may be more or less than the 6% I used.

You may want to invest between $50,000 and $100,000. My data set did not have much information on that range, although you can probably see the trends and get a good gauge of the results by extrapolating out.

There are plenty of variables that can change these numbers. Despite this, the data provides enough information for you to see trends. Any change in numbers will either minimise or exacerbate the trends, but may not change the results too much.

Final Thoughts

Index funds are a great way to invest for a buy and hold investor. You will outperform over two thirds of market participants over the long term and at a lower cost. Not to mention much less time spent researching and analysing stocks.

This is because active investors either have trouble picking the winning stocks or they let their behaviours and biases impact on their decisions and end up buying and selling at the wrong time. In a one year period you may have a large number of active investors outperforming the index. Over 5 years and the number may half. And over 20 years the number of active investors that outperform the market will be minimal. It is easy to win once, but to consistently win is a different story.

If you perform as well as the market then you will be better than average thanks to the majority of active investors performing worse than the market after costs. Index investing is better than average.

I think the stock market is seen as a scary place because of the company failures we hear about. And yes that may be the case for active investors who can’t invest in a wide range of companies. Index funds are so broadly diversified that it doesn’t matter if a few companies fail because there will be many more succeeding.

All these index fund options may seem overwhelming for a beginner. But keep learning one new thing every week and after 6 months you will be in great shape and well on your way to building an ideal portfolio of stocks and bonds that suits your investment goals. For the differences between the major fund providers you can read the recap here.

Finally, although low cost is important, don’t let cost get in the way of your investing goals. If the lowest cost provider has a fund that means sacrificing on some of your goals, or differing on your ideal portfolio, then maybe go with another provider. Even if it means slightly higher cost. I like the Smartshares world 50 fund because it is more diversified than the other world funds. It isn’t the cheapest, but that is ok with me as it aligns with my goals and is still reasonable cost. I am willing to pay a bit more, otherwise I would be investing in a fund I am not comfortable with. You may like Superlife’s auto rebalance function, or Simplicity’s ethical investing. Maybe you like Sharesies platform.

What matters is what is important to you and what is most likely going to keep you investing. It is a long game and you need to be motivated, so that means going with the fund that best suits you. Only then should you compare costs once you have narrowed down your potential funds. Too often I see people picking funds based on lowest cost alone and then being unhappy with the fund because it didn’t align with their expectations. Low cost is good, but it needs to suit.

At the end of the day, there is not a huge difference in costs between the providers. An investor would most likely do well just getting started in any index fund for the long term.

The Significant differences in costs arise when there are differences in fees of more than 0.2%. Often, active fund managers such as banks and mutual fund companies can charge over 1% or 2% more than passive index funds for the same (or worse) pre cost return. After cost return is what you keep in your pocket, and high cost funds can eat away at these returns to the tune of hundreds of thousands of dollars if they are not returning a difference of more than the cost of their service.

If you look closely at the make up of your actively managed fund, you will find that many of the active fund managers are investing in index funds now! Yet still charging you higher fees for the privilege.

There are enough index funds now to be able to find one that suits your needs without breaking the bank in fees. Whatever you choose you want to be able to sleep soundly at night.

Thanks for reading.

The information contained on this site is the opinion of the individual author(s) based on their personal opinions, observation, research, and years of experience. The information offered by this website is general education only and is not meant to be taken as individualised financial advice, legal advice, tax advice, or any other kind of advice. You can read more of my disclaimer here