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Index Funds and ETFs

Step 6 of 14 in the pathway Investing for the first time
Previous: Why not to bet on one thing · Next: Picking shares or buying a fund

📊 Tracking the Whole Market

Index funds and ETFs have become hugely popular with everyday investors, and for good reason. Instead of paying someone to try to beat the market by picking stocks, they simply track a market index, owning a slice of everything in it. That brings low fees and instant diversification, which suits long-term investors well.

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Key Point: An index is a list that measures a market, such as the largest companies in a country. An index fund holds all the investments in that index, so it tracks the market rather than trying to beat it. An ETF, or exchange-traded fund, is a fund that trades on a sharemarket like a share. Both give instant diversification at low fees, which is why passive, index-tracking investing has grown so much. They aim to match the market, not outperform it.

What an Index Is

An index measures the performance of a group of investments, for example the biggest listed companies. When you hear that a market is up or down, that is usually an index moving. An index fund simply owns what is in the index.

Index Funds vs ETFs

FeatureIndex fundETF
Tracks an indexYesYes
How you buy itThrough the fund or a platformTraded on a sharemarket like a share
DiversificationBuilt inBuilt in
FeesUsually lowUsually low

💡 Why They Are Popular

Low Fees

Because an index fund just holds the index rather than paying analysts to pick stocks, its fees are usually much lower than an actively managed fund. Over decades, that fee difference compounds into a meaningful amount, as covered in our fees guides.

Instant Diversification

One purchase can give you a slice of hundreds or thousands of companies. That spreads your risk widely, so no single company failing has much effect on your overall investment.

Buy one index fund or ETF
Instantly own a slice of every company in the index
Pay a low fee for that diversification
Track the market's return over the long term

They Match, Not Beat

An index fund aims to match the market's return, less a small fee, not beat it. Many actively managed funds, after their higher fees, struggle to beat the index consistently, which is a big reason index investing has grown.

Matching the market is a strong result: It sounds modest, but capturing the market return at low cost beats most attempts to outguess it after fees. That is the core appeal of index funds and ETFs.

🔍 Choosing and Using Them

What to Look At

  • The index it tracks: A broad market, a country, or a sector.
  • The fee: Lower is generally better for similar funds.
  • Diversification: Broader is usually safer than a narrow sector.
  • Tax treatment: PIE funds use the PIR; overseas holdings can involve FIF rules.

ETFs Trade Like Shares

An ETF is bought and sold on a sharemarket during trading hours, so its price moves through the day. That flexibility is handy, but for long-term investors the day-to-day price is far less important than staying invested.

Still an Investment, Still Moves

Index funds and ETFs are diversified, but they still rise and fall with the market. In a downturn, a market index fund falls too. They reduce single-company risk, not market risk, so the same long-term, stay-the-course mindset applies.

See our Diversification guide and use the Investment Calculator to project growth.

💡 Common Mistakes

Mistake 1: Thinking Index Funds Cannot Fall

They are diversified, but they still track the market down in a downturn. They cut single-company risk, not market risk.

Mistake 2: Picking a Narrow Index and Calling It Diversified

A single-sector or single-country fund is less diversified than a broad global one. Check what the index actually covers.

Mistake 3: Trading ETFs Constantly

Because ETFs trade like shares, it is tempting to buy and sell often. Frequent trading adds cost and rarely helps; long-term holding is the point.

Mistake 4: Ignoring Fees and Tax

Even among index funds, fees vary, and tax treatment matters. Favour low fees and get your PIR right.

A Simple Approach

1. Pick a broad, low-cost index fund or ETF
2. Understand the index it tracks
3. Invest regularly and hold for the long term
4. Do not trade in and out on market noise
5. Mind the fees and your tax rate

See our Investing Basics and Shares vs Managed Funds guides. Final word: index funds and ETFs track a market at low cost with instant diversification, aiming to match the market rather than beat it, which suits patient long-term investors. They still move with the market, so the stay-invested mindset matters. This is general information, not financial advice.

🎯 Test Your Knowledge

Quiz on Index Funds and ETFs (20 Questions)

1. What does a sharemarket index measure?
The performance of a group of investments
Your personal wealth
A single company only
Interest rates
2. What does an index fund do?
Tries hard to beat the market
Holds a single stock
Holds only cash
Holds what is in an index to track the market
3. What is an ETF?
A type of bank account
A single bond
A fund that trades on a sharemarket like a share
A savings scheme
4. Both index funds and ETFs offer:
Guaranteed returns
No fees ever
Single-stock risk
Instant diversification at low fees
5. Index funds and ETFs aim to:
Always beat the market
Avoid the market
Guarantee profit
Match the market, not beat it
6. Index fund fees are usually:
Higher than active funds
Lower than actively managed funds
Zero
Set by you
7. One index fund purchase can give you:
A slice of hundreds or thousands of companies
One company
Nothing
A bank deposit
8. Many active funds, after fees:
Always beat the index
Charge nothing
Struggle to beat the index consistently
Hold only cash
9. Matching the market at low cost:
Is a poor result
Beats most attempts to outguess it after fees
Guarantees losses
Is impossible
10. An ETF's price:
Never changes
Is set once a year
Moves through the day as it trades
Is fixed by the bank
11. In a downturn, a market index fund:
Cannot fall
Always rises
Is unaffected
Falls too, since it tracks the market
12. Index funds reduce:
All risk
Single-company risk, not market risk
Market risk only
Nothing
13. A single-sector index fund is:
The most diversified option
Less diversified than a broad global one
Risk-free
The same as cash
14. Trading ETFs constantly:
Adds cost and rarely helps
Is the best strategy
Guarantees gains
Removes fees
15. When choosing an index fund or ETF, you should look at:
Only the logo
Nothing
The index, the fee, the diversification, and tax
The advert
16. PIE index funds use:
The PIR for tax
GST
No tax
A flat 50% rate
17. For long-term investors, the daily ETF price is:
The most important thing
A reason to trade hourly
Irrelevant to fees
Far less important than staying invested
18. Even among index funds tracking the same market:
Fees are identical
There are no fees
Fees vary, so favour lower ones
Higher fees are better
19. The core appeal of index investing is:
Beating the market every year
Capturing the market return at low cost
Avoiding all risk
Guaranteed profit
20. The overall message about index investing is to:
Track a broad market cheaply, invest regularly, and hold for the long term
Trade ETFs daily
Pick one company
Avoid all funds

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