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 providers in NZ 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% today? Seriously, if you know- 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 to 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 off 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 that is 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 what the average return on the NZX-50/NZSX40 for the last 69 years was. 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 just 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.
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 you should remember this too when it comes to your investment. Here it is;
I looked at them, and calculate my monthly returns, which showed an annual interest of -22%. This got me scared. But, rather than pulling out my funds- I did the research 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.
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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