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"By periodically investing in an index fund, for example, the know-nothing investor can actually outperform most investment professionals."
– Warren Buffett, in Berkshire Hathaway shareholder letter in 1993
These are the wise words from Warren Buffett given some 31 years ago. In his letter to shareholders, Buffett advocated for the index investing strategy for general investors, but what is it?
Index investing, which involves tracking market indices rather than trying to beat them, has gained traction due to its simplicity and cost-effectiveness. It is often referred to as a passively-managed investment strategy.
Why choose unit trusts for passive index investing?
When it comes to index investing, ETFs (exchnage-traded funds) comes to mind for many investors. In fact, mutual funds or unit trusts that are index tracking can provide unique benefits for long-term investors.
1. Local currency exposure
The largest and most liquid ETFs are often priced in hard currencies, such as US dollars, which may not be the natural base currency for many investors. For example, a Hong Kong investor would need to first convert his/her money into a foreign currency (i.e. HKD to USD), thus incurring a currency conversion fee, just to invest.
You’ll have to do the same upon redemption. The two-way currency conversion fees behind foreign-listed ETFs add another layer of fees and hassle.
2. No dividend withholding tax
Most importantly, most Hong Kong investors could be subject to 30% dividend withholding tax when investing in US-listed ETFs as there is no tax treaty between the US and Hong Kong.
Learn more: An inconvenient truth: Taxes on US-listed ETFs
3. No bid-ask spreads
Unlike ETFs, unit trusts have no bid-ask spread concerns, potentially resulting in lower overall costs. They may also have lower tracking errors, closely mirroring the index's performance.
What is tracking error?
Tracking error happens because indexes are theoretical. While replicating the index performances, managers of index funds and ETFs face challenges and frictions, like transaction costs and timing differences, which can cause performance differences from the index. Asset managers work to minimise these frictions.
How clients can adopt the passive investing strategy in their portfolios through Endowus
The Endowus Investment Office has curated our Passive Index Collection which consists of funds that track various broad market indices, such as the S&P 500, MSCI World, or Bloomberg Global Aggregate Index.
Passive index collection: List of funds
Capturing the growth of the broader markets
History proves that the world’s largest companies are unlikely to remain the largest. Big, well-known companies can be disrupted and replaced in their industry.
Rather than buying and holding individual companies, buy-and-hold indices or broad-based strategies can capture the overall growth of a market or several markets.
Why invest passive index funds with Endowus?
Endowus offers mutual funds at zero subscription fees and switching costs, the access to lower-cost institutional share class funds, which are not normally available to retail investors at other distributors.
As a result, we have helped our clients achieve an estimated US$40 million of cost savings per year. That’s how you can lower your investing expenses over time and keep more returns on your investment.
Click here to get started on Endowus today or check out our other curated fund offerings on Endowus Fund Smart.
Frequently asked questions
What is an index fund and how does it work?
Index funds are investment vehicles that track the performance of a specific market index, such as the S&P 500 or the MSCI World Index. The objective is to match the performance of the indices, rather than to outguess and beat the market, by replicating broad market exposure.
Is index fund good for beginners?
Passive investing offers a stress-free yet scalable way to diversify your portfolio. By purchasing units in index funds, you can effectively own hundreds or even thousands of companies. For instance, the MSCI World Index comprises 1,429 constituents across 23 developed markets. This approach aligns with Buffett's wisdom, allowing you to space out purchases and benefit from long-term market growth without the need for extensive stock-picking expertise.
Are all index funds ETFs?
This is a big misconception that all ETFs are passively tracking the markets, while all mutual funds are actively managed. The truth is, that numerous ETFs are not indexed or traded actively, and many also track different sub-sectors of a single country’s market. At the same time, there are also unit trusts that are passive-indexed funds.
What should I note if I invest in passive indexes?
The weighting method of the index being tracked, the exposure of the underlying index, and tracking error and potential active risk in your “passive” index investment are the three things to know before adopting an index investing strategy.
Read more:
- ETF vs mutual fund — which is better?
- An inconvenient truth: Taxes on US-listed ETFs
- Why invest through Endowus
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Risk Warnings
Investment involves risk. Past performance is not an indicator nor a guarantee of future performance or returns. Projected performance or returns is not guaranteed to materialise. The value of investments and the income from them can go down as well as up, and you may not get the full amount you invested.
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General risk warnings relating to collective investment schemes
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Complex Products
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