Sunday 28 July 2013

Background and Investing our Superannuation in Index Funds

This post will contain many links, as I want to get to the best deals in superannuation more quickly and much of this has been covered by others.  I'm happy to expand on any of these points down the track if there is demand.

For those needing a primer on Superannuation more generally, a good starting place is ASIC's MoneySmart

Basically Superannuation is a 'container' for your assets.  The advantage is that, within certain limits, a permanent employee can salary sacrifice and pay only 15% tax rather than their marginal rate, and then 15% on earnings (with potentially lower rates still on capital gains).  The disadvantage is that generally the money isn't available until age 60 (with some exceptions).  Just like your own money, your Superannuation can be invested in many different assets such as cash, term deposits, shares, bonds or property.  What options are available to you depend on the superannuation fund you choose (and most people do have choice these days).

There may be many individual reasons for choosing a particular fund.  You may get a particularly good rate on Life, Total & Permanent Disability or Income Protection Insurance through your fund.  Your employer may subsidise or match additional contributions to a particular fund.  The main focus of this blog will be on what low-cost funds are available in Superannuation in Australia, in particular index funds.

What is an Index Fund and the case for Index Funds

When you look at the performance of your Superannuation your provider will usually compare the performance of your fund against an index such as the All Ordinaries or ASX200 index in Australia.  For example the ASX200 represents a capitalisation (size) weighted average of the top 200 publicly listed companies in Australia.  There are similar indices generated for global shares, bonds, etc.

One way of investing is to invest in the components of the index.  That way you'll always be close to the index or 'market' return.  Thankfully we don't have to buy the individual components of the index, there are funds set up to do this for us.  You may think that way you'll only get an 'average' return but there are a number of reasons this isn't the case.  The main advantages as I see them:

  • Index funds are much lower cost, as much less needs to be spent on research and salaries.
  • There's no evidence from either academic or professional studies that fund managers can consistently outperform an index, even putting aside the extra cost.
  • On average this means we can expect a bigger balance in retirement, with lower risk
More details on the advantages of index funds are available on the bogleheads site and forum: Advantages of Indexing
James L. Collins has some great posts about index investing on his blog also, such as this link
EDIT: Another (freely available) look at Index Funds in a portfolio in Rick Ferri's Whitepaper

There are some excellent books on the topic also.  My personal favourites deal with Asset Allocation in greater detail also (how to select the proportion of shares and bonds, international shares, etc. in your overall portfolio).  These are by William J. Bernstein:
And a less intimidating read if turned off by the word standard-deviation: The Investor's Manifesto: Preparing for Prosperity, Armageddon, and Everything in Between

Books often recommended more generally on Index Funds are by John C. Bogle, the 'father' of index investing, such as Common Sense on Mutual Funds
Or in the spirit of Bogle: The Bogleheads' Guide to Investing
Larry Swedroe surveys the evidence in great detail: The Quest for Alpha: The Holy Grail of Investing
An overview on Investing for retirement comes from Rick Ferri (and I've linked to the free pdf version on his website as the book 'Serious Money' is out of print)

Note that these books and sites are somewhat US-centric.  However the principles are certainly applicable to Australia.

If you're convinced that low cost and index funds are a good strategy, my next post(s) will discuss how we can invest in these within Superannuation in Australia.

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