Indexing options in your super fund: Pros and cons

After international investment giant Vanguard launched its own super fund in Australia in November 2022, many non-investment types were scratching their heads and wondering why all the fuss and what indexing had to do with their super.

In fact, Vanguard is already a big player in the Australian investment market as one of the largest providers of index exchange traded funds (ETFs), popular with individual investors and SMSFs. Behind the scenes, it has been providing indexed investments to large super funds for many years.

Although some Aussies have already dipped their toe into indexing as an investment strategy when they invest through an ETF, fewer have used the same investment approach with their retirement savings.

Now that Vanguard is offering its indexed investment services directly through a “low-cost, high-quality” super product, it’s timely to learn a bit more about how indexing works and what it means for your retirement savings.

What is an index (or benchmark)?

An index is a collection of investment assets that are grouped together to represent all or part of a broad investment market. It provides an easy way to measure and benchmark the performance of a set of investment assets.

There are indexes for almost every asset class (such as Australian and international shares, property and bonds), as well as for currencies and commodities.

Within each asset class you can also invest in indexes covering a subgroup of assets. In the case of shares, this might be the industry (such as resources and financials), sector (such as the largest global technology or healthcare companies) or geographic region (such as the 20 biggest Asian or European companies).

Investment indexes are designed to reflect the value and market performance – both up and down – of the asset class, sector or industry to which they relate. They are constructed by large international investment companies like Barclays, S&P, Morgan Stanley and Bloomberg.

The performance of well-known local and international indexes (such as the S&P/ASX All Ordinaries, Dow Jones and NASDAQ) is covered daily in the financial media.

Indexing: How does it work?

Indexing is an investment strategy designed to provide exposure to the performance of a specific investment market by tracking the performance of its key index.

To track the index, an investment manager buys assets in the same weighting as they occur in the index they are tracking. The aim is to match or duplicate the return of the index by investing in the whole index or a representative sample of it.

Indexing is sometimes referred to as passive investing as it involves passively buying the market, rather than trying to actively beat the performance of the market by selecting investments you believe will outperform.