All about Index fund or ETF

Took me a some time to write it. Please don't fall asleep. Lol. Anyways, here we go:

You will hear the term ETF and index over and over again. It is paramount that we understand this fundamentals of ETF and why it might be all you need to know about investing.

So, What is ETF or Exchange traded fund?

It is a share/token that consists of shares of multiple companies.

So if you buy a fund or ETF you are actually investing in all the companies that the ETF holds. Most popular example of ETF is “S&P 500”. If you buy one S&P 500 ETF, Your money would be invested in top 500 companies in the US.

Now nobody knows the top 100 companies in USA let alone top 500 by their name. Then why we are investing in these unknown companies. Why don’t we invest in giants like Apple, Facebook, Microsoft or Unilever? The truth is that You could but lets see why rather than investing in a single company, investing in a broad ETF like S&p 500 is more sensible.

Let’s look at this example . Lets go back few years . Year 2000. you want to buy a share of a big US company . You are looking to invest for long term. May be for your retirement. You want to buy a share and keep that for 25 years.

You look at the top companies in the US and you find a company called Nokia. Yes, you know the name. They dominate the smart phone market and as smartphones are the next big thing, so you decide to buy £60k worth of Nokia shares. About 1000 shares and each is £60. Good, you are flying , you are going to be rich in next few years. The stock has returned about 400% in last one year. In this pace your 60k would be worth millions. You are all set for your retirement in 2025.

Fast forward to June 2024, you still have 1000 share but each now worth £3. Your 60k is now less than 3 grands and it is likely to only go down.

If you invested in NTT(7th biggest company in 2000) your £63k would be now worth £330 yes, just about 300 pounds.

However if you bought Microsoft shares in October 2000, your £63k would be worth, wait for it, 1.3 million.

So in a nutshell , you don’t know if apple is going be around in 2030 or even 2026.

So rather than speculation you invest in all the companies together and if USA companies are doing ok then you would do just fine.

The following is a vital piece of information for long term investment.

We just talked about S&P 500, the index fund for best 500 US company. This is a great investment as long as USA remains the economic superpower in the world. This is likely to be the case for next 5-10 years but what about next 30 years? Not so much I guess. Have a look at the photo.

In 1900 UK was 25% of total economy and now 2.3%.

In 1990, just 34 Years ago Japan dominated the market and now barely making 4% of Global GDP.

So the main question here is, how sure are we that USA is going to dominate in next 30 years. If the answer is yes then S&P 500 is the best investment out there but if you think China or even India or Russia could take a large bite of the global economy, then should we invest all our money in US market? What if USA becomes the next UK in next 20 years?

Well, thats why a more diversified fund like a global fund, which invests in 3000-7000 companies all across the globe might be the right fund for you.

If you are not even sure that USA as a country going be leading the economy in few years you can buy global ETF like “Global all cap” which invests in 7000 companies around the world.

So overall the more diverse your investments are the less risk you have to loose your money.

Just for comparison:

if you bought £60k worth of S&P 500 in 2000, your investment today would be worth £250k .

If you bought £60k worth of “Global all cap” ETF in 2000 your investment would be worth £210k

So the return is a bit less when you spread more but it gives you more stability.

Here are some popular ETFs:

S&P 500 ( 500 top US companies)

FTSE 100 (100 top UK companies)

FTSE developed world ( Top companies in the developed world: North America, Europe, Japan etc)

FTSE emerging market ( China, India, Thailand etc)

FTSE all world ( Almost 3000 companies in the world)

FTSE global all cap ( Almost 7000 companies in the world)