Index funds a safe, work-free method of sharemarket investing for anyone (2024)

Recently I wrote about a unit I bought 20 years ago for $220,000 which is now worth $550,000. I pointed out that the same money invested 20 years ago in a fund that matched the All Ordinaries Accumulation Index would now be worth $1.23 million

One reader gave me a dressing down. He claimed that he put $300,000 into a portfolio just before the GFC and lost a third of his capital. Fifteen years later the portfolio still has not recovered. I pointed out to him that according to my stock market calculator his portfolio would now be worth $738,000 if the money had been invested in a fund that matched the All Ordinaries Accumulation Index, and assuming all dividends are reinvested.

This made him even more unhappy. He told me it's impossible to invest in a product that matches the All Ordinaries Accumulation Index because such an animal it does not exist - and furthermore that I was gilding the lily by even mentioning the Index. He claimed that it would be far more ethical to select stocks such as AMP, BHP or Telstra.

This information is wrong in so many ways, but it's worth a discussion for anybody thinking of investing in shares. It's true that no investment matches the All Ordinaries Index exactly. Why would you want to? It contains about 2000 companies and 85 per cent of them could be described as businesses with no cash and no hope. Many of them are speculative mining companies.

But the essence of the index is the top 300 companies, which make up 85 per cent of the total value and produce 97 per cent of the profits and dividends. And there most definitely are products that track the top 300 companies, such as the Vanguard Australian Share Fund (ASX.VAS). This fund started on 30 June 1997, and Vanguard tell me if $100,000 had been invested when the fund started, and all dividends were reinvested, the portfolio would now be worth $732,412. That's a total return of 632.4 per cent after management fees and transaction costs.

The stock market calculator on my website is an educational tool, which shows monthly values from 1 January 1980, when the concept of the All Ordinaries was formed. It enables people who are considering investing in shares to run "what if" scenarios. You can enter a notional investment sum and a notional finishing and starting date to see how an investment would have performed if it matched the Index.

To check the validity of my calculator I ran the Vanguard numbers through it. The answer was $775,000, a compound gain of 675 per cent. The difference between the two is insignificant. The reason I never use specific shares when I'm talking about performance is that requires a degree of skill in picking winners, which the average person does not possess.

The main risk with picking individual stocks is buying duds. That is always a risk with individual companies - even household names, including so-called "blue chip" companies like ANZ, Qantas, Myer, etc. But the chances of the entire market covered by broad index funds going bankrupt is almost zero. Broad index funds have beaten the vast majority of professional fund managers the vast majority of the time.

Time and time again I have heard people tell me they want to invest in shares but they don't know where to start, as they wouldn't have a clue about picking stocks. My response has always been to invest in an index fund: there are no decisions to make; it pays around 4.5 per cent annually, which is mainly franked; it cannot go broke; and over the last 120 years it has averaged around 9 per cent per annum. That's good enough for me.

Q&A

Question

You have often written that, to avoid the death tax, it's good policy to liquidate all your superannuation and deposit it in your bank account prior to your demise. I have a self-managed super fund with a family company as trustee. How quickly and efficiently can I do that since I have accounts in my super in both accumulation and pension mode? Also are there any potential complications in transferring the proceeds of the sale (in the company's name) into my personal bank account?

Answer

The basic issue here that you need to get the money out of superannuation to avoid the death tax on a benefit left to non-dependent. It need not necessarily be in cash. You could transfer the shares in specie to your own name as a member benefit and that would have the same effect as placing the money in the bank. Seek advice about whether it's possible for you to move your entire fund to pension mode before you make the transfer. If it's possible earnings of the entire fund will be tax-free and there should be no CGT payable by the fund when the assets are transferred. The ability to do this will depend on whether you have any unused transfer balance cap.

Question

We own our home and have an investment property worth $1.1 million generating $650 per week. We have $300,000 in super between us. The investment property was bought in 2007 and was our home until 2020. Our income including the rental is around $100,000 a year. We are 60 and 62 and intend to keep working for the foreseeable future. Should we sell the rental and contribute $300,000 each to our super funds and give the kids a deposit for their own homes leaving us with combined super of around $900,000? Or should we keep it? We are thinking it would be easier to sell and help the kids and also become eligible for a part pension.

Answer

Big factors in the decision to sell the investment property are capital gains tax and the potential of the property. This is something only you can decide. I agree that it's good to help the children sooner rather than later, and if getting a part pension is one of your goals, you could make them gifts for a house deposit from the sales proceeds - after five years, when you are nearing pensionable age, those gifts would cease to exist for Centrelink purposes. Just be aware that in that time, the Centrelink thresholds could change and your superannuation could go to a level where you were over the threshold for the assets test.