Index Funds in New Zealand

Index funds are becoming more and more popular in New Zealand, with good reason. They offer instant diversification and easy access with one purchase, all while tracking market returns and having some of the lowest fees in town.

That said, there are hundreds of index funds to choose from. To choose the right mix for you, it helps to know a thing or two.

In this guide, we’ll cover:

• What is an index fund?
• Advantages of investing in index funds in NZ
• The downsides of index funds
• How to invest in index funds
• Index fund fees explained
• ETFs vs index funds
• Index funds and KiwiSaver
• FAQs

Indexes are lists of companies, usually designed to measure the performance of a certain market or sector (like the 500 biggest companies in the US). Index funds (like the S&P 500) track those lists to replicate their performance - holding shares in the companies included.

When you buy an index fund, that means you’re effectively buying shares in all the companies in that index in one go.

One of the most important features of index funds is that they’re passive. In other words, some guy in a fancy suit isn’t researching the market and individual companies to try and pick winners. Instead, the fund just automatically tracks an index, so the costs are much lower.

Read a more detailed definition of index funds

Index funds are a fantastic investment option for many Kiwis - especially those who want to build long-term wealth over 5, 10, 20 years or longer. Here’s why.

Index funds usually charge lower fees than actively managed funds. While the difference might seem minimal, even slightly higher fees can have a huge impact on your returns over time. Here’s an example.

Let’s assume that you and your friend both had $100,000 to invest over 20 years.

You both chose funds that happened to consistently return 7% each year. However, you chose a fund that costs 0.25% p.a. while your friend chose a fund that costs 1.00% p.a.

Assuming both had equal performance, you would’ve earned $368,072.73.

In contrast, your friend would’ve earned $316,504.18.

That’s $51,568.55 that you saved purely on fees!

Read more about investment fees

Fees shouldn’t be viewed in a vacuum - what’s also important is the return, after fees are deducted. A common misconception is that a fund charging higher fees, also generates higher returns. The problem is, actively managed funds that generally charge higher fees don’t consistently achieve higher returns than cheaper index funds - quite the opposite. Research from S&P Global shows that the vast majority of actively managed funds fail to beat market benchmarks consistently.

You can’t control the performance but you can control the fees you sign up for.

More info on active or passive investing

Index funds are a bundle of shares, so when you buy units of an index fund you’ll own shares in dozens, or even hundreds of companies.

This provides instant diversification, which is pretty nifty. Now, for example, if one company held in the index tanks, you mightn’t lose as much money compared to if you held it individually, because that loss will be balanced by other companies' gains. Think of it as putting your eggs in lots of different baskets.

A well-diversified portfolio has exposure to lots of different sectors, geographies, and trends - many customers go even further and buy more than one index fund. You can invest in local funds, global funds, sustainable funds, future funds, you can shape your portfolio to reflect your values, goals or life stage.

Read more about diversification

Choosing more volatile investments like shares in a single company, crypto, or thematic funds usually requires a little extra research and due diligence. Diversifying these investments then requires hours of work, identifying and buying multiple different assets.

So, if you’re time poor and want maximum results from minimal input, you could keep your strategy super simple with index funds. Choose a few that suit your goals, appetite for risk, and values and follow the investment fundamentals mentioned here, over the long term many investors earn returns that closely match the market..

The tax efficiency of investments might not have you on the edge of your seat, but it can have an effect on returns by keeping more of your money invested. When you invest offshore - such as in global companies or international ETFs - you face the potential of tax leakage. This is the unnecessary loss of returns due to inefficient structures, double taxation, or missing out on available credits.

Our Kernel PIE funds are designed to give Kiwi investors access to global investment opportunities while reducing this leakage. Over a long period of time, even a little difference in the tax efficiency of your investments could save you thousands of dollars. For example, an investor with a 39% individual tax rate and a $100,000 investment returning 5% p.a. ($5000 income before tax), under the PIE fund PIR rate capped at 28%, they’d be paying $550 less each year compared to their individual tax rate. Over time that adds up!

Read more about building a tax-efficient investment portfolio

The main downside of investing in index funds is that you’re not going to get better than market returns, since most of these funds are designed to closely match them, not exceed them. It’s worth noting that very few managed fund investors are able to do this consistently either, and that market returns are nothing to scoff at.

There's also a common misconception worth clearing up: index investors don't just get average returns. Because active funds charge higher fees, those costs eat into their returns. Once you account for that, the average index investor actually ends up with above-average returns. It's simple maths.

Index funds don’t offer as much flexibility compared to portfolios of individual shares. If you had a portfolio made up of individual shares, for example, you might be able to identify a few companies you hold that are more likely to be affected during a downturn, sell them before it happens, then invest in others likely to be more resilient. The problem is, doing this requires lots of knowledge, expertise, time and maybe a crystal ball - most professionals don’t even get it right.

While index funds don’t offer as much flexibility as other investments, they’re designed for you to be in for the longer run. Over any 5 - 10-year period, investors typically live through multiple waves of uncertainty like inflation scares, recessions or geopolitical events that impact markets. The key is to remember that volatility is the price paid for higher expected returns.

Read more about the art of staying the course here.

1. Set your goal

To invest successfully, you first need a goal, or goals. This shouldn’t just be a number; it should be meaningful.

For example, it’s pointless to set a goal to just have a million dollars in investments or to own 10 properties. Instead, you should start with what you want to spend it on whether that’s something physical like a home or car, experiential like a holiday or education, or emotional, such as the feeling that you can retire in comfort.

This makes it easier to persevere and make the tradeoffs and sacrifices necessary to reach your goals.

Read more about setting investment goals.

2. Choose a provider

You can use multiple providers to invest in index funds, so have a look around and compare all your options.

• Compare fees across similar funds.
• Check out their online platform - is it easy to use, self service, with good functionality?
• What’s their customer service like?
• What’s their approach to investing?
• What are their online reviews like?

Read MoneyHub’s guide to index funds in NZ to get started and look at a few of the market-leading options.

To sign up with most providers, all you’ll need is your ID (NZ drivers license or passport), your IRD number, and bank account details. Most can also accept foreign passports, but you’ll need to get in touch with them.

You’ll need to fill out a form (usually online) and this should only take a few minutes. From there, you can tinker with the platform, deposit some funds, and start buying investments.

3. Design a diversified portfolio

All investments have some level of volatility and will go up and down in value. To protect yourself against this volatility, you can consider diversifying your portfolio.

This spreads your risk to reduce your exposure to a particular company’s failing or fall from grace, tough times for specific sectors, and other events you can’t foresee. While diversification reduces exposure to individual company risks, it does not eliminate the risk of loss.

There are a number of strategies you could use to do this, but core-satellite investing is a great option for many. Here’s a quick run down:

• The ‘core’ of your portfolio (around 80-90%) are broadly diversified low-cost index funds.
• The rest (10-20%) are your satellite investments which are a bit more speculative - stuff like thematic funds, ETFs, or individual shares are worth a look.

If you’re a newbie, read more about how to start investing. This guide covers everything from setting goals, to choosing investments.

4. Build good habits

For most people, investment success doesn’t come from taking huge risks or picking winners. Instead, it’s about small actions, taken regularly over time. Investing regularly over years or decades can generate huge returns, without requiring you to spend your evenings figuring out what’s going to happen next (let’s be honest, these days nobody knows).

To make it even easier you can set and forget your investments. Just set up a direct debit or payment into your wallet, then an auto-invest to purchase your index funds on a regular basis, every time you get paid is a great option.

Index funds typically charge fees as a percentage of the funds invested per year. For example, if you buy $1,000 worth of a fund with a 0.25% management fee, you’ll be charged $2.50.

Some funds also charge additional fees. These might include entry fees, penalties for missing a direct debit, transaction fees, membership or account fees and more. It’s important to know the fees before investing - if you’re not sure, ask your provider via email, or read the fund’s product disclosure statement in detail.

I’m frequently mistaken for chubby Liam Hemsworth. Similarly, ETFs are often mixed up with index funds, but they’re definitely not the same. The main difference is that ETFs (or exchange traded funds) are bought and sold, also known as traded, on a public stock exchange. An ETF can also be actively managed or index tracking.

Whereas index funds can be structured as an ETF, but they can also be unlisted, meaning you invest directly through a fund manager instead. In this example we will be comparing an ETF to an unlisted index fund.

ETFs allow investors to buy a basket of assets (like shares or bonds) in a single transaction and often (but not always) track indexes like the S&P500, so they can be very similar to index funds, but there are a few key differences to remember in a New Zealand context:

• Because you buy unlisted index funds from a fund provider, you generally get one price per day and the transaction happens “off-market”. Whereas ETF prices fluctuate throughout the day based on trading.
• Unlisted Index funds trading occurs less frequently, for example, many trade once a day, which is much slower compared to ETFs (during market hours).
• ETFs can cost a bit more to buy and sell than unlisted index funds because investors need to pay brokerage and foreign exchange fees.
• If you hold global ETFs they may not be as tax-efficient as NZ-based index funds due to tax structures.
• Dividends are usually auto-reinvested into unlisted index funds whereas ETFs often suffer dividend drag, which is the delay between when the dividend is received and when it’s invested.

What this all means is that when you invest in ETFs, you might lose a proportion of your returns to inefficiencies in tax, trading, and management. That’s not to say ETFs aren’t worth investing in. It’s just that they may be best used as ‘satellite investments’, whereas index funds may form the ‘core’ investment.

Want more detail? Read more about ETFs

If you’re choosing a KiwiSaver fund, it helps to understand what’s available. Some providers offer a small range of diversified options, like cash, conservative, balanced, or high growth funds. These bundle investments together for you based on different risk levels.

Others give you more flexibility. If you’re comfortable taking a more hands-on approach, you can build your own mix using index funds such as the NZ 50 ESG Tilted or Global ESG and more.

Whichever route you choose, one thing to keep in mind is your investment horizon, or the amount of time until you want to use your money. Your fund choice should reflect that timeframe and the ups and downs that can come with it.

• If you’ve got 0-2 years: it’s a good idea to stick to cash or conservative funds.
• If you’ve got 2-5 years: you might look at a balanced fund or similar.
• If you’ve got 5-7+ years: it’s worth looking at high growth funds or index funds, where your longer timeframe can account for more volatility that comes as a trade off for potentially higher returns.

If you’ve got less time, you’re more vulnerable to volatility. If you’ve got more time, you can likely ride out the ups and downs of the market (volatility) to benefit from a long-term upward trend.

Read more about investment horizons

Sort of. Lots of ETFs track indexes, which means they’re put together similarly to index funds. The difference is ETFs are traded publicly on a stock market and index funds are not.

All investments involve some level of risk, but some index funds are less risky (or volatile) than others. Some invest in mainly cash assets, bonds, and other conservative asset classes, and these come with relatively lower risk - whereas others that invest in growth assets like equities, have higher levels of risk.

Risk isn’t inherently bad, the trick is matching levels of risk to your investment horizon and your goals.

The Sorted Smart Investor tool makes it easy to compare index funds. Simply tick a few boxes to narrow down your selection, then scroll through the options. You’ll see returns averaged over five years, fees, and asset mixes - side-by-side and easy to compare.

Most index funds, including Kernel’s, are registered with Inland Revenue as multi-rate Portfolio Investment Entities (PIE). In April each year an amount of tax is due for the previous 12 months, and this is usually automatically calculated by your provider.

Read more about tax and index funds.

That’s totally up to you. There’s no minimum investment with Kernel, and every little bit makes a difference. Your aim shouldn’t necessarily be to invest as much as possible, but rather to invest what you need in order to reach your financial goals.

Read more about setting financial goals

Kernel Wealth Limited is the manager and issuer of the Kernel KiwiSaver Plan and Kernel Funds Scheme. A Product Disclosure Statement is available at Kernel Wealth | Resources & Documents. Investing involves risk including the possible loss of principal and there is no assurance that the investment will provide positive performance over any period of time. The information provided should not be relied upon as investment advice or recommendations and should not be considered specific legal, investment or tax advice.