The benefits of index investing

The benefits of index investing

If you’ve only got a minute:

  • Without prior knowledge, index investing is one of the easiest ways to get started on investing.
  • The benefits of index investing are that it requires little financial knowledge, has relatively low fees and has diversification benefits.
  • Common ways to do index investing include lump-sum investing or committing to a dollar-cost averaging strategy.

At first glance, investing can seem very complicated, especially for those just starting out. Newbies have to make sense of investment jargon and understand the myriad of investment instruments, among others. In fact, many studies have shown that people have avoided investing altogether due to the perceived difficulty of understanding these terms.

These temporary “inconveniences” aside, the fact remains that investing presents opportunities to make your money work harder.

One of the most accessible ways for retail investors to get started is by investing in index funds that track major world stock market indices.

This has been championed by some of the most successful investors of all time including Warren Buffett. In May 2020, the chairman and chief executive of American multinational conglomerate Berkshire Hathaway shared: “In my view, for most people, the best thing to do is owning the S&P 500 index fund.”

The good news is there are many easy ways to invest; you don’t have to worry about picking individual stocks, and hiring an expensive advisor isn’t always necessary.

So what exactly is index investing?

Index investing refers to investing in exchange-traded funds (ETFs) and to a lesser degree, unit trusts, which aim to match the performance of the underlying index as closely as possible.

An important point to note here is such funds do not aim to outperform a particular market index but to replicate its performance as closely as possible. As these funds only mirror performance, they do not require active management by investment professionals. This means there are often lower investment fees for investors all while they gain exposure to diversified basket of stocks.

Globally, the Standard and Poor’s 500 (S&P 500) is undoubtedly the most well-known index but in Singapore, many are also familiar with the Straits Times Index (STI).

Straits Times Index (STI)

The STI is a market capitalisation weighted index that tracks the performance of the largest 30 companies listed on the Singapore Exchange (SGX).

With a such an index, the weight of each company in the index is determined by the market capitalisation of the company divided by the sum of the market capitalisation of all the companies in the index. This means that larger companies take up a larger proportion of the index.

With a set of blue-chip stocks, the STI is often regarded as the benchmark index for the stock market in Singapore. By extension, it serves as a representation of the performance of the Singapore stock market.

Some of the companies in the index include local companies like DBS, Singapore Airlines and Singtel so investing in this index can often also be seen as investing in the largest public companies in Singapore.

S&P 500 Index

Similar to the STI, the S&P 500 Index is a market capitalisation weighted index. The index features 500 leading publicly traded companies listed in the US. This includes household names like Apple, Microsoft and Amazon.

The S&P 500 index is often regarded as one of the best gauges for the performance of the US stock market.

The benefits of index investing

Benefits of index investing

1. Requires relatively little financial knowledge

Investing in index funds is relatively easier than building a portfolio on your own. Building a portfolio on your own often requires learning how to look at the balance sheets of companies you plan to invest in.

Even after learning, you will still have to spend time to conduct extensive research into the companies you want to invest in. You will also have to continuously monitor the performance of the companies that you have invested in and keep up with the latest news about the companies in order to determine if the company is still worth investing in.

2. Low fees

Index funds provide a cost-effective route to investing in a portfolio of stocks. Not only do you save time from having to rebalance your portfolio, but you are also likely to save money in the form of lower overall fees as the cost of buying and selling individual stocks tends to pile up for the retail investor who are likely trading at a lower ticket size (i.e. the number of shares per purchase).

Being passively managed, index funds generally have lower management fees than other funds. As the index fund just mimics the designated index, you save on having a research team to analyse securities and make recommendations.

3. Diversification

By just investing in index funds, your portfolio becomes diversified, which in turn, reduces the risk you are taking. For example, investing into STI would allow your portfolio to not be overly concentrated in the relying on the fortunes of a single company as there are 29 other companies that are part of the index. This reduces the likelihood of losing some or all of your money.

However, buying the STI does not provide geographical diversification. As the STI comprises of 30 companies listed on the SGX, the performance of the index is also correlated with the performance of the Singapore economy. Therefore, most people would want to construct a portfolio of multiple ETFs when investing in order to achieve greater diversification.

The benefits of index investing

How to get started?

One of the most basic strategies for first-time investors to consider is dollar-cost averaging (DCA).

But what exactly is DCA?

It is a simple idea: Invest in fixed intervals at fixed amounts – no matter what the market condition looks like.

This can be done using a regular savings plan (RSP) which requires you to set aside some money to invest on a regular basis. DBS Invest-Saver is an example of a RSP that allows you to invest with as little as S$100 a month.

As with all investing styles, there are pros and cons to DCA too as well as some misconceptions.

Another typical investment method is lump-sum investing. With this, you invest a chunk of money instead of committing to a monthly investment sum. Lump-sum investing tends to be used by individuals who have sufficient funds to make a series of purchases in stocks or pooled investment products (e.g. unit trusts, ETFs).

One other way to do lump-sum investing is through a robo-advisor. Many robo-advisors consist of a series of ETFs and unit trusts, which affords you diversification. The proportion of how your money is allocated with each of these pooled investment products is dependent on your risk tolerance.

DBS digiPortfolio is an example of a robo-advisor that you can invest in from a minimum of S$100.

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Disclaimers and Important Notice
This article is meant for information only and should not be relied upon as financial advice. Before making any decision to buy, sell or hold any investment or insurance product, you should seek advice from a financial adviser regarding its suitability.

All investments come with risks and you can lose money on your investment. Invest only if you understand and can monitor your investment. Diversify your investments and avoid investing a large portion of your money in a single product issuer.

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