I think index funds are the number one investment vehicle you can use to gain your financial independence. They provide you with diversification and low fees. They are passive, and the whole process can be automated. That is why I recommend you to also invest in Index Funds.
But aren’t they risky?
You probably have the same idea as everyone else who is starting out investing. “Can lose all your money in an index fund”.
You’re not alone; a large proportion of Kiwis feel this way too when it comes to investing in an index fund. The common belief is investing in index funds are; too risky, complicated, and reserved for the wealthy. All these are false, my friend.
Index funds are not complicated!
Index funds are not complicated. Take the NZX-50, for example. It’s just an index/number that tracks how well the 50 biggest companies in NZ are doing. If the companies do well- the number goes up. If the companies do badly- the number goes down.
Index funds are not reserved for the wealthy!
You can now go to several NZ providers to invest in index funds- Sharesies, SmartShares, InvestNow, are a few. All of them offer low fees, and you can start investing with as little as $250. And they allow you to buy both local and international index funds.
Index Funds are not Risky!
This is the one that I wanted to discuss with you.
On average, the S&P 500, which is an index- has returned 9.8% over the last 90 years. That’s over 90 years- probably longer than you or I will live- statistically speaking. And where else today can you get a return as good as 10%? Seriously, if you know- please tell me.
That doesn’t sound risky to me- if you can invest your money and get a return of 9.8%. Hang on- that is the S&P 500. What about the NZX-50?
Yes the S&P 500 is an American Index tracking their biggest 500 companies. We don’t have 500 large companies to follow in NZ. So we have the NZX-50, which tracks the largest 50 NZ companies.
How has the NZX-50 performed?
This data is harder to find. Especially, if you want to look really far back.
The data is hard to find, but everything is on the internet. So we can work out how well the NZX-50 has performed and figure out how risky investing in the NZX-50 was. After all, last month, I had noticed that my investment in the NZX-50 had dropped by -20.1% annual rate of return.
That’s risky- or is it?
I found the raw data for both the NZX-50 and the NZSX-40. It took NZ a while to get 50 big companies, so we started with 40. So, the NZSX-40 is the predecessor of the NZX-50. It changed from the NZSX-40 to the NZX50 back in 2003.
Both data sets combined go all the way back to 1949. And like any data nerd, I spent the weekend crunching numbers for you. It was raining anyway.
Firstly, I wanted to replicate the graph floating on the internet about the odds of losing money in the S&P 500. It shows the odds of losing if you were to invest for several different time periods. One day, Six Months, one-year etc.
Basically, it breaks down how risky investing in an index fund it. It should hopefully ease your mind and want to make you invest in an index fund.
Odds of losing money in the NZX-50
I calculated the odds of losing money for the NZX-50. The figure below shows the odds of losing money if you had invested in the NZX-50 over different investment periods.
So for example, if you had invested in the NZ market for a period of only one week, in any time between 1949 to 2018, you would have a 45% chance of losing money.
But, over an investment period of 25 years- the odds of you losing money is 0%. That’s not a rounding error. There was literally no 25 year period in this data, from 1949 until 2017, where you would have lost money.
The graph shows us that if you want to lower your risk, you need to invest in index funds for the long term.
Like the S&P 500 graph showed, if you are investing for 10 years, you only have a 3% odds of losing money. Those are some pretty good odds!
Average Gain of the NZX-50
Secondly, I wanted to calculate the average return on the NZX-50/NZSX40 for the last 69 years. And to compare if it was performing as well as the S&P 500s average of 9.8%. That is an easy one to calculate.
Below is a graph of the NZX-50 performance over time.
Over the period of 1949 to 2018, the average return of the NZX-50 has been 7.8%. That includes the NZSE-40 as well. So the returns are a little lower than the S&P500, but still a good return.
If you look at the NZX-50 from 2003 until 2017, the average improves to 10.2%. That is above the average of the S&P 500. Not bad for 50 Kiwi companies aye.
The Verdict
To sum this all up, investing in the NZX-50, like an index fund, is not risky if you invest over a long period. The average return is good, even if there are years of big losses, such as 2008 (-32.8%). There are also big years, such as 2017 (22%). And a whopping 72.2% in 1985.
I broke a simple rule of investing in index funds. And it would be best if you remembered this too when it comes to your investment. Here it is;
I looked at them and calculated my monthly returns, which showed an annual interest of -22%. This got me scared. Rather than pulling out my funds- I researched to reassure myself that index fund investing is the way to go.
And the results show exactly that! That should reassure you that investing in index funds is perfectly safe, and can get you a good return on your money.
Disclaimer
Forgive me; I have interchanged the terms index funds and ETFs throughout this peace. They are different but similar. They are both a portfolio constructed to match a stock index, such as the NZX-50. The index that follows the 50 largest NZ companies. Check out this article from Investopedia.com if you want the technical differences between the two.
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Amazing stats about the long run! It doesn’t surprise me that there was 0% chance of losing money when in it for 25 years. I think its even more the case today with the current financial system, quantitative easing and inflation.
Thanks for sharing, you have a new follower here
Mike
Thanks Mike! Thought I would do the work on the NZX-50 since there are already similar stats floating around for the S&P 500. Defiantly started looking into index funds more now!
Yeah have you read Tony Robbins book? There’s also a book called the millionaire teacher by Andrew Hallem. Both say the same thing. If your in it for the long haul find good index funds and find ones with the lowest fees. Paying half a percent more for fees each year adds up in the long run.
Really enjoyed this read thanks
No I haven’t read that. Definitely one to put on the reading list!
You can lose all your money in an index fund – but it’s very unlikely unless it’s a poorly designed index fund (which I don’t think even exists). But in order for an index fund’s value to go to zero there would have to be some world-ending cataclysmic event, in which case your money would be worthless anyway.
Thanks for the comment Joe. You can say the same about property. You could also loose a lot of money in the property market. Funds for me give me access to an investment with good returns at a very low cost of entry compared to property and other investments. Low service fee too.
Index funds are good for those who do not know about stocks and those who think they know everything about stocks. Pretty much covers a major chunk of the population. The only risk I see with index funds is valuation. But, like you mentioned staying invested should fix that problem.
I would love to learn about stock analysis and looking into company. I just don’t think I have the time to actually become an investor, rather than just a speculator and choose stocks based on a “feeling”. I agree, I think stocks are a great option if you dedicate yourself to doing the research. With index funds, I think there is less research involved.
Where did you get the data for the NZX50? I’m wondering what probability for different return/loss brackets is for each of the investment durations you have listed.
Downloaded the data from Yahoo finance.
Hi Rohan, coming late to the party. I’ve recently started looking into passive investing and index funds and something that keeps circling in my head is this: an index is something measuring performance of a group of assets (stocks). Now, an index fund tries to replicate that same performance by investing in the same assets that the index is tracking, and by doing so it invariably will affect the index. Why? Stock value is affected by supply and demand, so if a company is doing well, more people will want to buy it so its price goes up. Therefore the index goes up (let’s assume, all other stocks within the index remain the same). But what happens when people start investing in an index fund following that given index, the index fund will buy those stocks and then the price goes up, doesn’t it? If the index fund is large enough, the “power” of the fund compared to the overall “value” of the index might be significant to push its value up. And with the surge in popularity of index funds, millions are poured into them. Wondering how that might actually affect the index. I haven’t done the math yet to see if for example index funds following NZX-50 and what their value is compared to the value of the index itself are large enough to cause any issues, but thought of raising the question.
Great site by the way! I’ve just subscribed and will be going through all the posts!