Mr Christopher Tan’s obsession with index funds started more than a decade ago. He liked the funds not only because of their lower costs, but also because he saw that most actively managed funds do not perform better than average returns of the markets. Thus, index funds generally are better placed to outperform actively managed funds.
What is an index
For instance, The Straits Times Index (STI) comprises 30 constituent stocks with familiar names such as the big local banks, Singapore Airlines and other well-known companies.
“If the Singapore stock market goes up, then your fund will go up. If it comes down, your fund will come down. There are many index funds around the world that track different indexes, such as the S&P 500 etc, so in simple terms that’s what actually an index fund is all about.”
What about exchange-traded funds or ETFs?
Buying an ETF is akin to buying a listed stock, but in this case, this “stock” is essentially a basket of index stocks.
“When you buy one share of the ETF, you actually own a basket of these stocks from the index,” Mr Tan explained. “So an ETF is actually a very good way of investing because the costs are even lower than an index fund.”
How to buy
“You can buy an ETF that tracks the United States S&P 500 from the Singapore stock market. But it is not very liquid and what that means is that when you want to buy and sell, it takes a bit more time to get it traded and the cost can be higher.
Investors can also buy the S&P 500 from the US market, but they have to be willing to put up with trading in a different time zone and also deal with the tax implications of buying an ETF that’s traded in the US. It’s not rocket science, but you need to have an interest and need to do a little bit of homework. You need to open a stockbroking account.”
Managed vs index funds
According to Mr Tan, the two things investors should be wary about when investing in funds are tracking error and costs. He reckons that the advantage of investing in index funds is that investors do not have to worry whether fund managers are picking the right stocks to beat the market.
“You don’t really have to worry too much about track record because their track record is the market. They’re not trying to beat the index, but if you buy an actively managed fund that tries to beat the market, you’ve got to see who is the manager managing it.”
“The other thing that you have to be aware of is the cost. If you are buying those very expensive unit trusts and investment-linked policies that Singaporeans love to buy, you are looking at an at least 1.5 per cent management fee. So if you compare 0.2 per cent with 1.5 per cent, the difference is your return.”
Retail investors buying ETFs don’t need a fund manager. All they need to do is open a stockbroking account.
“So you just need to have a broker and you can buy off the exchange through the broker if you are buying an ETF. But again, I just want to advise listeners to be careful and be mindful of tax issues such as estate duty tax, withholding tax etc. So do your homework, and don’t just buy off any exchange,” Mr Tan said.
For more, tune in to Your Money with Michelle Martin on weekdays from 9am to noon.