What an index fund is
A share index is a list of companies: the NZX 50 is the 50 biggest companies on the New Zealand sharemarket, and world indexes cover thousands of companies across many countries. An index fund (or an index ETF, which you can buy and sell on the sharemarket like a share) simply buys them all, in proportion to their size. Nobody picks winners, so it’s cheap to run.
Why it usually wins
- You get the market’s return. Some companies soar and some fail, but you own all of them.
- It’s spread out. One company going bust barely moves an index fund.
- It’s cheap. Index funds often charge 0.1% to 0.3% a year. Actively managed funds often charge 1% or more.
- Most stock pickers fall behind. Studies of fund performance in many countries, such as S&P’s SPIVA reports, find that most actively managed funds do worse than their index over 10 to 15 years.
What fees cost you
$10,000 invested for 30 years, growing 7% a year before fees:
| Yearly fee | After 30 years |
|---|---|
| 0.1% | $74,017 |
| 1% | $57,435 |
| Difference | $16,582 |
The fee comes out every year, and so do the returns it would have earned. Many KiwiSaver and managed funds also charge a small fixed fee in dollars, which takes a bigger share of a small balance.
Over 30 years, a 1% fee costs you
$16,582
- You keep (1% fee)$57,435
- Lost to the higher fee$16,582
Assumes a 7% return every year before fees. Real returns vary, but fees come out every year.
How they’re taxed in New Zealand
- NZ funds and ETFs are usually PIEs. The fund pays the tax for you at your prescribed investor rate (PIR): 10.5%, 17.5% or 28%. Make sure yours is set correctly.
- Funds of overseas shares are taxed on 5% of their value each year under the foreign investment fund (FIF) rules, at your PIR, whatever they earned.
- Overseas ETFs you buy directly, for example on a US exchange: if your overseas shares and funds cost over $50,000 in total, you work out the FIF tax yourself in your tax return. Under that, you’re taxed on the dividends.
See capital gains in New Zealand for the details.
Picking your own stocks
It can be fun, and some people do well, but:
- A few stocks are risky: one bad result can wipe out years of gains.
- Trading costs add up if you buy and sell often, and if you buy shares to sell them at a profit, the gains are taxable income.
- It’s hard to tell skill from luck over a few years.
If you want to try, keep it to a small share of your money, and the rest in index funds.
How to start
- In KiwiSaver: check what your fund invests in and what it charges. Many providers offer index or passive funds, and Sorted’s KiwiSaver fund finder compares them. You can switch funds or providers at any time.
- Outside KiwiSaver: many investing apps and fund managers offer low-fee PIE index funds, often from small amounts. Check the provider is on the Financial Service Providers Register, and that the fund’s manager is licensed by the FMA.
Invest money you won’t need for at least 5 years, and keep going when markets fall: selling in a panic turns a temporary fall into a real loss. Start with investing basics if you’re new, or see where to invest.