Index Fund Investing, Israel Edition – Part II: Assets, Securities and Funds

This post is part of a series: How do I start investing in index funds? Israel edition. Read the posts in order here:

Selecting what you actually want to invest in is the most important stage. The brokerage you use and the way it will be structured tax-wise are secondary considerations.

There are a few major asset classes:

  • Equities (stocks & shares)
  • Bonds (government & corporate)
  • Cash
  • Commodities (like gold and oil)
  • Property*

There isn’t enough space here to discuss all of the advantages and disadvantages of these. See here for much more info. Of course, you don’t have to choose just one asset type; a standard strategy is diversifying across several asset types. Equities have historically given the highest return over very long periods (at least 20 years – see below for a more thorough demonstration of this). Investing in them requires you to really be in it for the long haul, and be able to stomach events in which your net worth halves in value, believing that in the really long term, you’ll end up making more money.

Diversification within asset classes

Even within each asset class, it makes sense to diversify in order to lower volatility and the risk of losing all your money. If you invest in just one stock (say, Apple), you might centuple your wealth in a few years; on the other hand, you might lose it all. Better to invest a bit in lots of companies. Companies are listed on a stock market, and there are indices that track the performance of them as an aggregate. Even better, there are funds that you can buy which track exactly these indices, called index funds. This is my chosen approach (passive investing), which I’m going to focus on, as I’m most familiar with them.

There is more diversification to be done, even within the asset class of equities. You could have one fund tracking large, international companies (“large-cap”) and another tracking small, more domestic-market-focused ones (“small-cap”). You can diversify across industries (note that you already achieve this by buying general stock market index funds, as one stock market will contain companies from a range of industries). You can diversify across geographical regions: North America and Developed Europe, Japan, Asia-Pacific; and across market types: Emerging Markets vs Developed Markets.

Each of these markets has a passive index fund that you can buy that just tracks the index as closely as possible. The fund manager that is the household name is Vanguard, the champion of passive index funds, with extremely low fees (passive funds generally have much lower fees than active funds). If you want to be really lazy (and the goal of this is to be lazy, and trade as infrequently as possible, leaving the fund alone to grow) you could even just buy one single All-World fund, and there’s nothing wrong with that. There are also Israel-based passive fund managers who track exactly the same indices, such as Tachlit, IBI and Migdal.

A classic portfolio has a certain percentage of equities (high risk) and the rest bonds/cash (low risk). The standard advice is to have a high proportion of equities if you’re young (far from retirement), such as 80:20 (or even higher, if you dare), as you have lots of time to ride out the drops and peaks of the market; and as you grow closer to retirement, to gradually increase the proportion of bonds.

More on index fund investing

As mentioned, my chosen approach is to invest in passive index funds. I want to take a moment to discuss my reasons for this. Many people believe that investing in the stock market is kind of like gambling; that it requires a lot of knowledge and time spent researching companies; that you could one day wake up and find that you have lost all your money. Of course, anything is possible in the future. But I want to briefly demonstrate that this has simply not been the case in the past, and there is good reason to believe this will continue into the future.

S&P
S&P 500 index over the last two decades

Here is a graph of the S&P 500, an index of the 500 largest publicly traded companies in the US. Shown in the red arrow is the terrible crash of 2008, one of the worst crashes the stock market has ever suffered (a drop of more than 50%), leading to the Great Recession. Note, however, that even someone who invested just before the crash, at the most expensive possible moment, would still find themselves with a decent profit today, if they just left the money there and didn’t touch it. On October 9th, 2007, the index closed at 1,565.15 points, then its highest ever closing value. Ten years later, on October 9th, 2017, the index closed at 2544.73 points. This means that, even just in terms of capital gains, the investor would be up by 62%: an annual gain of 4.98%. That’s before we even take into account the dividends paid out by many of the companies in the index, adding another 2-3% to the nominal gains. So even after cherry picking a terrible moment to invest, we find that with enough nerve and patience, the return is still good.

Now, it’s possible that the current market is a bubble, and prices will drop massively again. Who knows? Anything can happen in the future. So I’ve done some analysis on the total returns (capital gains + dividends) you’d get from any 10-year, 20-year, 30-year and 50-year period over the last 90 years or so for an S&P 500 investment (i.e. considering each 10-year investment period of 1928-1938, 1929-1939, 1930-1940 etc.). This is what I found:

s&p returns
The real (i.e. beyond inflation) annual return for investments over various lengths of time.  The table shows the best historical returns, the worst historical returns, and the average historical returns for each investment duration.

What’s shown here? Firstly, “real” means that inflation has been taken into account: these figures show how much your money has increased over and above inflation. Take the first column: it shows that the best 10-year period (1948 – 1958) would have given you a 17.82% annual return, whereas the worst 10-year period would have given you a -4.15% annual return (buying in 1998 and selling just after the crash of 2008). The average 10-year period gave a 6.28% return.

So for a 10-year period, it’s still possible to lose significantly, assuming you’ll blindly sell when the market is down. But once we widen the net to 20 years, there has been no 20-year period where your money loses value. The positive return becomes even more certain for a 30-year period. For a 50-year period, the minimum return the market has ever given is 4.25% per annum after inflation. Not bad for what we thought was kind-of-like gambling! And, indeed, it’s not really gambling. Because what you’re doing is buying a piece of ownership in the most successful companies in America, such as Apple, Google, Boeing and Coca-Cola. The goal of these companies (as instructed by their owners, including yourself!) is to make a profit for their shareholders. They may pay this out as dividends or reinvest it into the company. You’re investing in real companies with real customers and real value creation: this is not just a bet on red.

Why passive index funds? Theoretically, you could be clever and select better companies that have more growth potential and make a bigger profit. Who doesn’t wish they had invested in Apple or Tesla a decade ago? But you’re unlikely to be smarter than the people whose full time job it is to research this stuff (though you might be luckier). You could hand your money to an actively managed fund where they do this for you, but actively managed funds typically perform worse than the underlying index against which they benchmark themselves. This is mainly because of their much higher management fees, which eat away at your gains. Passive index funds have exceptionally low management fees. Why try to beat the market when the return is already good from just matching the market?

I’m not going to tell you where to put your money

This has to come from you. Firstly, I’m not an investment advisor and the opinions expressed here are my own and not advice yada yada. But secondly, this is your money that you worked hard to earn. My own investment choices are based on assumptions that I’ve made. It’s my own money that I invest, so the risk is mine alone. I can throw away my money if I like, and if my thinking turns out to be wrong the suffering will be my own. But the suffering will be yours if you lose money in an investment. So the decision and choices have to come from you, after informed research. Don’t go mental with the research though, because there’s always more you can learn, and at some point you have to take the leap into the market or you’re wasting time in which you could be getting a return.

Choices, choices, choices

Now it gets complicated. Let’s say for the sake of argument that you’ve decided to invest in US large-cap stocks, tracking the S&P 500 index. How do you implement this decision?

You’ll need to find a fund manager which runs a fund whose objective is to track the performance of the S&P 500 index. There are many fund managers that do this. Here are some of the things you’ll need to consider:

  1. Which index you’re going to be investing in (already assumed S&P 500 above)
  2. You could buy a foreign-domiciled one or a domestic (Israeli) one. Despite the location, all of these funds track the same index. A foreign fund manager could be Vanguard USA, Vanguard Europe, iShares, or other. A domestic fund manager could be Tachlit, Psagot, Harel, or other.
  3. The fund structure. There are 3 in Israel: Keren Ne’emanut (Mutual Fund); Keren Sal (ETF) which is like a mutual fund but is traded throughout the day on the stock market like a share; and Te’udat Sal (ETN) which is being phased out and replaced by Keren Sal. Overseas, you generally have to have residency to be able to buy units in mutual funds, leaving ETFs as the key investment vehicle for foreign investments.
  4. The fund manager and fees – and thus the specific fund: consider carefully the annual fees, and entry fees if any, that they collect from your investment.
  5. You’ll need to think about which stock exchange you’re going to buy the fund on – usually it’s through the stock exchange of the domicile country, but not always. For instance, Vanguard Europe’s ETFs are domiciled in Ireland but traded on the Irish Stock Exchange, London Stock Exchange and SIX Swiss Exchange.
  6. The currency in which the fund units are denominated: the Israeli ones will typically be denominated in shekels; foreign funds may have several currency options for the same fund! For example, Vanguard’s Irish-domesticated S&P 500 ETF is denominated on the LSE in GBP and USD, on the Swiss Exchange in CHF, and on the Deutsche Borse in EUR!
  7. Dividend treatment: do they pay out the dividends into your brokerage account (“income fund”), or do they reinvest the dividends automatically in the fund (“accumulation fund”), reflecting this by raising the unit price? Which do you want?

Wow, so confusing! And that’s even without tax considerations or considerations about your brokerage fees. But it’s not as complicated and it sounds, and a lot of the points cross over and restrict each other, so there aren’t as many combinations as implied. Numbers 2-7 are the levers that you can pull to optimise at the tax-level and brokerage-level while not compromising on the fundamental goal: tracking the performance of the S&P 500 (in this example).

Fund name breakdown

Before I finish, let’s break down the title of a couple of funds: I think this is an informative exercise.

Vanguard FTSE U.K. All Share Index Unit Trust – Accumulation

  • Vanguard: this is the name of the fund manager.
  • FTSE UK All Share Index: the index that the fund tracks. In this case it is the index of all publicly traded companies in the UK, as defined by the FTSE Group (an indexing company).
  • Unit Trust: this is the fund structure. It shows us that it’s a mutual fund, and the members of the mutual fund (i.e. people who invest) buy “units” which are like shares in the fund.
  • Accumulation: this means that the fund reinvests the dividends automatically, and reflects the increased value by raising the unit price instead of paying you the money.

Vanguard S&P 500 UCITS Fund

  • Vanguard: this is the name of the fund manager.
  • S&P 500: the index that the fund tracks.
  • UCITS Fund: UCITS is an EU regulatory framework; usually when we see this it means it’s an ETF governed in the European style. This fund is an ETF. It gives no indication in the name that it’s an income fund, although in the factsheet we can see that the dividends are distributed (so it’s an income fund).

תכלית S&P 500 TTF

  • תכלית: this is the name given to funds managed by Meitav Dash.
  • S&P 500: the index that the fund tracks.
  • TTF: I thought this was a special fund structure, but a quick Google shows that it actually stands for Tachlit Tracking Fund. Apparently, the Israeli fund managers obnoxiously name their passive mutual funds TTF, MTF (Migdal), PTF (Psagot), KTF (Kesem). Looking at the factsheet shows that it’s a mutual fund (also look at the URL). The index tracked is actually S&P 500 NTR, which another quick Google shows means the Net Total Return, i.e. both capital gains and dividends together – implying it’s essentially an accumulation fund. Point is, just keep googling terms you don’t know until you understand everything.

In the next article we will discuss brokerages – the platform you use to buy and sell investment instruments such as funds.

Continue to Part III: Brokerages –>


Recommended reading:

Asset classes

http://monevator.com/asset-classes/

http://monevator.com/uk-historical-asset-class-returns/

Investing

https://www.mrmoneymustache.com/2011/05/18/how-to-make-money-in-the-stock-market/

http://www.mrmoneymustache.com/2013/03/07/how-about-that-stock-market/ (and all the 16 articles linked at the end)

Choosing funds in Israel

(Hebrew) https://www.hasolidit.com/כך-תשקיעו-בזול-מהדורת-2017


*You don’t have to buy a house to invest in property! In fact, doing so is a horribly illiquid and non-diversified way to invest in this asset class, not to mention the high fees. You can buy a REIT, which is a property tracking fund, which has the major advantages of being liquid, diversified (across commercial, residential, medical property etc.) and not having to worry about physical management.

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4 thoughts on “Index Fund Investing, Israel Edition – Part II: Assets, Securities and Funds

  1. Pingback: How do I start investing in index funds? Israel edition – Part I: Introduction – Remember The Fish

  2. Mindy Goldberg

    Very helpful, thank you! I also recently stared following Mr. Money Mustache and have been trying to figure out the Israeli equivalents of these types of investments.

    Like

  3. Pingback: Index Fund Investing, Israel Edition – Part III: Brokerages – Remember The Fish

  4. Pingback: Do Israeli apartments outperform the stock market? – Remember The Fish

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