Index fund investing

How will index fund investing help you

Investing is thrilling and fulfilling. Just look at the traders on Wall Street to see the level of excitement that can be achieved. It’s comparable to the environment of a horse racing track! In a more generalised sense, it’s the opportunity to buy into something worthwhile and purposeful. The idea of becoming a shareholder in one of the great conglomerates or small entrepreneur companies of today is as satisfying as it is liberating. By inclusion you are announcing that you have options. The option to earn money from a vehicle other than conventional work practices and the option to raise cash in the time of most need. That’s security and it’s something very worthwhile.The investing exercise may seem reserved for stock brokers and the elite professionals but, in reality anyone can do it and it’s really easy! So easy in fact that once you are set up you can make a trade within 5 minutes via your smartphone. There are many pathways to take in investing but, in my experience albeit somewhat limited I have come to realise that there is no easy or fast way to generate wealth when applying sound investment attitudes and principles. Wealth creation takes time and personal resolve. I have tried my hand in the trading of individual common stocks and while I recognised the hype experienced my the traders on Wall Street it’s a slippery path full of twist and turns and self doubt and questioning. When you are up, you feel euphoric. When you are down, you feel defeated. The sad reality of this approach is that most people trading in this manner will lose more often than they win which equates to feeling depressed more often than elated.

Enter the no load low cost index fund investment strategy. This approach is the essence of simplicity and in an ever increasing complex world, simplicity is the holy grail. Index funds are passively managed funds that track a major market indice such as the Standard & Poor’s 500 Index (S&P 500) or the Russell 2000 Index of the US equity market. Unlike other actively managed funds that incur high operating expenses (such as management and research staff remuneration, administration costs including sales and marketing) and high turnover costs (buying and selling incurs transactions costs and capital gains), index funds are low cost counterparts. And costs matter. The difference between a management cost of 2% on an actively managed fund and that of 0.07% on a passively managed index fund could mean an increase of 67% on a 30 year investment – a result from doing absolutely nothing additional on your part.

Index Fund Investing Calculator

How this calculator works

The purpose of this calculator is to demonstrate the process, investment schedule and outcomes of index fund investing. By entering factors as your payment contribution, payment frequency, investment term and fund costs the model will calculate out the cashflows and term fund value.

An example

Assume you are just starting out and you have no money in a current index fund. You are keen to begin your investment journey and see what you could amass by your predetermined retirement in 30 years. After completing the How to budget your money worksheets you have determined you can contribute $200 each fortnight to the fund. You have investigated a few low cost online brokers and successfully applied with one of them. They have a minimum trade value of $500 and the brokerage commission on such a value is $14.95. You have also investigated index funds and decided on one that offers no load low cost passive management for all in costs of 0.07% pa on your investment balance at the time of annual calculation. You have estimated the annual return on your chosen index to be 10% based on long term historical results. Your current bank account pays 3% nominal interest on your balance and the long term historical inflation rate in your country has been around 3%.You plug all this into the model and the results are tabulated. Instantly, you will be able to see the cashflows between your bank account and the index fund, in this case $600.69 will be transferred every 3 fortnights (6 weeks). You will also notice that in 30 years your estimated closing fund balance could be $948,460.41 with a personal contribution only amounting to $156,180.07, a 607% return on your investment for little effort and a lower risk profile than if you were to invest on your own stock picking abilities.

Limitations

Personal circumstances differ and because of this taxes have been excluded from the model. Taxes are an important factor and should be considered in your final evaluation.

Instructions

Walk-through:

  1. Enter your beginning fund balance – if you have a nil balance enter zero (0)
  2. Enter your payment contribution – this is what you plan to contribute on a regular basis to the fund
  3. Enter your annual payment frequency – how often you will transfer funds into your bank “holding” account. If you plan to contribute $200 each week then enter 52 (52 weeks in a year)
  4. Enter the investment term – in whole years, this is the full time period you expect to continue contributing payments to the fund.
  5. Enter the minimum amount for investment – whether you invest direct into the fund or through a stock broker there will normally be a minimum amount to trade. This can range from $500 to $3,000 so be sure to investigate this.
  6. Enter the fund management costs – this can make a profound impact on the outcome and is one of the key factors in decisions to be made. This expense ratio can range from 0.07-2.0% so research this thoroughly.
  7. Enter the stockbroker transaction costs – another cost in ownership. Every trade will incur a commission for the intermediary to process the order. The fee can range from anywhere as low as $14.95 (a minimum cost) to a full 0.59% of the trade value.
  8. Enter the annual rate of return from the bank “holding” account – this factor isn’t important for the purposes of this model simply because you won’t be holding large sums for long time periods in this account. Just enter an arbitrary figure that matches something close to the present federal cash rate. In Australia, this is currently 2.0%.
  9. Enter the annual rate of return from the fund – this IS important. Past performance IS NOT an indicator of future performance and any claims made by the fund for expected future performance should be taken with a pinch of salt. Studies have shown the long term expected return on major indices such as the S&P 500 on US equities to be 7-10% but, this still isn’t guaranteed to continue indefinately. That being said, we need to estimate something so 7-10% (erring on the side of caution at 7%) would be a sound approximation.
  10. Enter the estimated inflation rate – Check with your federal government for details on long term inflation rates. The default is set at 3%, an average demonstrated in Australia since 2000.

Index Fund Investment Schedule

All fields marked with * are mandatory
Beginning fund balance*
Input Value Without $
Payment contribution*
Input Value Without $
Annual payment frequency*
Investment term (years)*
Minimum amount for fund investment*
Input Value Without $
Fund management costs(%)*
Stockbroker transaction costs*
Input Value Without $
Annual rate of return from bank(%)*
Annual rate of return from fund(%)*
Inflation rate(%)*
Total payments made
Total interest received
Total transaction costs
Total management costs
Return on investment (ROI)(%)
Closing fund balance at term
Present value of closing fund balance at term

 

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