(The examples presented are specific to the Philippines but the lessons can be applied to any country. So even if you don’t live in the Philippines, the lessons here are still applicable!)
Yes, there is an easy way to invest in the stock market, and it is through index funds. It’s probably also the safest way to invest as well (since you won’t make “stock picking” mistakes).
This article is mostly for beginners and, after reading this, you will be able to determine if index funds are the investment for you. This article also outlines how you can actually start investing in the stock market through index funds, in case you determine you want to start.
I will say that index funds are probably also the most boring way to invest, but index funds are a surefire way to get good gains over the long-term with your investments. And remember: your goal is to profit from your investments, not to have fun!
Index funds are great for a lot of reasons:
- No stress on what stocks to pick as there are already a set list of stocks that compose the index funds
- The funds are also managed by a professional for you
- Historically good returns at average of 8% to 12% per year over the long-term
- Average returns are better than MP2, real estate, bonds and others
- Only requires about 10 minutes every month of your time to invest
- Even with your little investment, index funds are naturally diversified
Of course, there are some negatives for index funds:
- Should only be for long-term investments (at least 7 years but best to be 10 years or more)
- Not a good investment if you need quick returns in the short-term or medium-term
- Your money will not see gains for a long time
- Potential returns are good but not as great compared to when you pick individual stocks yourself
We certainly think the good traits definitely outweigh the bad ones, especially if you’re a new investor. And if you’re interested in knowing more about index funds, read on below.
In this article we’ll talk about:
- Who should invest in index funds
- What are index funds
- Why you should invest in index funds (and not active funds)
- How to start buying index funds
- Risk and returns in index fund investing
- Where To Go From Here
For now, before we start learning about index funds, let’s start by determining if index funds are even for you.
(Disclaimer: Any mentioned stock, company, fund name, or similar are not official recommendations but are merely examples for the point we are trying to make.)
Should You Invest In Index funds?
There are a couple of things you need to ask yourself before you invest in index funds. But the most important one is understanding that this is a long-term investment.
Index funds won’t give you returns immediately so you need to be able to stay invested over the long-term or basically at least 7 years at the minimum. This makes sure that the money you invest will result to profits.
Just like regular stocks, index funds go up or down in the short-term, but over the long-term, they will definitely increase as shown by historical evidence. But again, that could mean waiting for about 7 years or so to get good profits.
Essentially, the way your investment grows will probably be like this: absolutely no growth or it may even go down for 6 years or so, but on the 7th year or so, it just goes up by a lot! Is the money you invest okay to be tied up for that long?
Usually people who invest in index funds (and the stock market in general) are those with savings that they do not need, or savings that are for long-term goals. These goals can be retirement savings, savings for a house, or savings for their children’s college tuition.
Or maybe you just really want to be richer 10 years from now, as compared to your current financial capacity. And so you decide to invest your monthly savings, like what we do.
The other important question you need to answer is if you’re ready to invest, in general. You should also read our lessons on the 7 Easy Steps To Financial Freedom and Wealth just to make sure you’re really ready for investing.
If your money is going to be needed in the immediate future, then this investment is not for you. Honestly, there are no investments that make good returns in the short term with little risk, so I guess if you’re in hurry to make money, investing in general is not for you.
In that case, you’re better off looking for a good part-time job to supplement your income.
However, if you do have savings you want to grow at good rates in a low risk way, then read on below about index funds investing!
What Is A Stock Index?
An index is simply a measure of an entire stock market, or a section of it. The computations are usually made using a weighted average of the stocks prices (but that part is not that important right now.)
Let’s take the PSEi (Philippine Stock Exchange index) as an example. This is the standard index used for the Philippine Stock Market.
This index has 30 public Philippine companies that are carefully selected to represent the entire Philippine Stock Exchange. And yes, there are almost 300 public companies in the Philippines whose stocks you can buy, but only exactly 30 are chosen to be part of PSEi!
The average stock price movement (up or down) of the 30 companies are seen as the general movement of all the almost 300 stocks in the Philippines.
Well-known companies in this index includes the following:
- Jollibee Foods Corporation
- SM Investments Corp
- Ayala Corporation
- Philippine Airlines
- And so much more!
These 30 companies are changed depending on whether they still comply with certain requirements or not.
It’s useful to note that even when a company is part of the 30 stocks in the PSEi, that company can still be a bad investment. In other words, if you’re picking individual stocks to purchase, don’t just buy a company solely because they are part of PSEi!
The criteria to be part PSEi has something to do with how large their revenues and assets are, and how often they are sold and bought. There are no criteria that says they have to be good investments.
Generally, though, the companies in the PSEi are large and do well financially, so the whole PSEi still makes a good investment.
As mentioned, an index moves in relation to how the member stocks move. If Jollibee stocks go up, for example, and the other stocks remain the same price, then the index goes up.
In other words, if a lot of companies in the index goes up, and only a few companies go down, the overall index will go up by the net amount.
We’ll continue talking about indexes later, but let’s now talk about funds.
What Is A Fund?
An investment fund, or simply just a “fund”, is an investment where multiple people (including yourself) contribute different amounts of money in a pooled fund. The total collected funds are then used by a fund manager to purchase stocks, bonds and other investments depending on their strategy.
Some strategies are active, and we usually call these as active funds. Fund managers here do their best analyzing which specific stocks, bonds and other financial assets are the best investment for the fund’s money. Since they work hard, they also generally ask for higher fees compared to passive funds.
The performance of the active fund will depend on how good the manager is at picking good investments. Meaning that your gains (or losses) depend on the fund manager’s abilities, which are sometimes not great.
Passive funds, on the other hand, merely follow indexes as a strategy. The fund managers don’t really do much here as they just have to make sure that they buy equal amounts of stocks to follow the index. Because their job is easier, they also ask for smaller management fees.
In our PSEi example, the manager will essentially just divide the available fund money by 30 and buy equal amounts of peso value for each stock in the PSE index.
The performance of index funds will depend on the index. Meaning that if the index goes up, the index fund will also go up. If the index goes down, so does the index fund.
Should You Choose Active Funds or Passive Funds?
You can probably do alright investing in an active fund over the long-term. However, I always tell people that if you want an active fund, you’ll probably be better off just choosing the individual stocks and managing your investments by yourself instead.
In other words, don’t invest in active funds but rather just open your own broker account and start investing in individual stocks. These are essentially level 2 and level 3 in our levels of stock Investing article.
Choosing stocks by yourself is a lot easier than you think because your broker will be there to guide you with their research and recommendations anyway. And by choosing the stocks yourself, you can avoid the large management fees that comes with active funds. (This is why you won’t see me recommend active funds even though they can still be good investments.)
There is a saying: Why would you risk your hard-earned cash with a fund manager, when you are capable of losing that money yourself!
But that’s just a joke, of course.
But, if you want to invest in funds, index funds will be a lot better for multiple reasons.
Reason #1: Index Funds Are Essentially Assured Gains Over The Long Term
By long-term, we mean about 7 years at the least. But most of the time 10 years to 20 years is what proper investors define as long-term.
If the fund manager of an active fund makes huge mistakes, which they probably will, then your investments are at risk of large losses even if you are invested in the long-term.
Index funds, on the other hand, have historical evidence that over the long-term, your investments will always rise.
Don’t believe us? Here is the PSEi over the long-term, plus other indexes of different countries. Take note that even though they go down at certain points of time, they always recover and eventually go up by a lot!
If you invested in these indexes years and years ago, you’ll definitely see profits on your investments today. So investing in index funds now will enable you to see profits years and years in the future.
Reason #2: You Pay Less Management Fees
The annual management fees for index funds are usually only around 1% of the fund value per year, but the active funds have management fees of about 2% per year. That’s twice as much on average!
Reason #3: Index Funds Are Doing Better (On Average)
There have been numerous studies that span decades that tracked the performance of different funds using the active and index strategies.
The result? On average, index funds always beat active funds (and sometimes by a huge difference).
Of course, this is just on average and there are definitely active funds out there that earn more than index funds! However, the risk with active funds being mismanaged is still very real, even when that active fund’s performance has been great in the past.
If you just want to create steady wealth over the long-term with your savings, in a safe, low risk way… then index funds are the way to go.
So, How Do You Start Investing On Index Funds?
Let’s say you are ready to invest and you are convinced that index funds are what is right for you. Where do you buy index funds?
There are a lot of institutions that you are familiar with that offers index funds.
You can try checking out UITF index funds from banks like BDO, BPI, Metrobank, and any of the other banks with nationwide branches. Go to their website or google something like “bank name index funds” to get started.
You can also buy index mutual funds from investment companies like Sun Life, Philam, Philequity and the like. For a complete list of mutual fund companies, visit the official list in the sec website here.
Just make sure that you’re actually investing in “index” funds. Some of these companies might sway you to invest in their other products, like a VUL. These are not really good investments and they make more money for the seller. Stay focused! (More info on that soon.)
If you have a plan to invest in index funds for a few years while you learn stock market investing, and then switch over to individual stocks after, then you can consider brokers like COL Financial that offers both funds, and individual stock investing.
How To Choose A Good Index Fund
It’s not really that difficult to choose a good fund since the way they work and how they should be managed is extremely straightforward.
I am using COL Financial’s research fact sheet here but you can find similar information about other funds on their individual websites or inquire about this information from your selected companies/banks/financial institutions.
Just find the fact sheet on their website, or ask them a copy.
Also very important: There are so much info on the fact sheet, but you don’t need to understand all of them. Just follow the “Good Fund Criteria #s” below to determine what you should look for and how to evaluate them. Easy peasy!
Good Fund Criteria #1: Historical Performance Close To Benchmark
The benchmark here is really just the index that the fund is trying to imitate, which is PSEi in the case of the Philippines.
The index fund’s performance must be very close to the performance of that of the benchmarked index. This is because, again, the whole point of index funds is to follow the index movements (which will eventually go up in the long-term).
Here we have the fact sheet for a fund called Philippine Stock Index Fund, which is managed by BPI Investments. It’s symbol is XALSIF so we’ll call it that from here on out.
Again, since we are investing over the long-term, focus on the results over the past 3 years to 5 years, and even 10 years if that is available.
Take a look at the “Since Inception” or SI performance as well. This is the performance from the time the fund was created.
We can clearly see here that over those years, XALSIF’s performance has been very close to that of the index, which makes them a good candidate.
If the percentages are different for 5 years and 3 years by about 2%, then something could be wrong with the way they manage the fund. If that’s the case maybe find a different fund instead.
Remember: For index funds, being able to follow the index performance is our biggest concern.
Good Fund Criteria #2: Asset Allocation Should Be Close To 100% Equities
This means that almost all of the cash they receive from investors like yourself should be used to buy shares. Cash should not be kept.
The reason for this is simple: Again, the easy strategy in index fund managers to follow is to just buy the stocks that are part of the index. That way, the index funds will closely mimic the PSEi’s performance.
Almost zero brain cells are needed with almost no analysis on the part of the manager. They receive cash from you and other investors, then they use it to buy the listed PSEi stocks and that is it!
For XALSIF, we see that they have 99.19% of the money they have invested in equities (which is really just another name for stocks/shares.) This is what we want to see.
Good Fund Criteria #3: They Have Been In Existence For Over 5 years.
Nobody wants to trust a new company.
And while past performance does not indicate future performance, I would rather put my money in companies who has at least some experience rather than those with zero experience.
Better yet, why not invest in funds that have been here for at least a decade?
So that’s what we’re looking for here. The minimum is 5 years of existence since that would indicate they are over the initial phase for funds and are already stable.
Good Fund Criteria #4: Management Fees Is Around 1%
Management will take annual fees as a % of the value of the fund.
Make sure you don’t pay too much. Index funds usually have a fee of around 1% only. And if you ask us, 2% is probably too much, so you should probably avoid index funds that ask for 2%.
And that’s essentially what you’re mostly looking for. Easy isn’t it?
Risk And Returns With Index Funds
There is very little risk with index funds as long as you invest in them well.
This mostly means investing in the long-term, as we have stated at the start of the article.
Investing regularly also lowers your risk, especially when you buy during the times the market goes down. This lowers the average costs of your index funds which means that when the market finally goes up, you earn more profits.
So yeah, just invest regularly and stay invested for a loooooong time! And remember: Don’t sell your investments unless years have passed and you see profits!
I always say that the risk in the stock market is the same as the risk of being hit by a car when you cross the street. Sure, the risk is there, but as long as you take precautions like looking left and right first, and you follow traffic rules, you’ll be fine!
Returns (or profits) in the index funds are really great after 10 to 20 years. Generally, you’re looking at around 8% to 12% average per year.
Take note though that that is the average and does not mean that index funds will increase by 8% to 12% every single year. It mostly means that at the end of 10 or 20 years, the profits you get will be equivalent to as if the market actually increased by 8% to 12% per year.
So, don’t expect profits for the first few years, but on the 7th to 10th (and especially the 20th year), you’ll definitely be earning huge amounts, relative to your investments.
Where To Go From Here
If you’ve decided that index funds are definitely for you, then you can start investing on them by asking about it from your preferred banks or other financial institutions. We have listed some of them here in the article.
If you’re not sure yet, then don’t feel pressured. Read our other articles just to learn more and get a feel for investing.
We always say: The best investment is in learning about investments!
There is no need to rush. So just take your time learning before committing to an investment.
If you have any questions, ask us below! And also let us know what other investing and personal finance topics you want to know about.
Good luck I hope you learned something!