What the ASX 200, ASX 300 and S&P 500 are, how index funds work, and the risks to understand first.
Index investing has become one of the most popular ways for everyday Australians to build wealth, and for good reason: it is simple, low cost, and does not require you to forecast which companies will do well. This guide explains what an index is, how the main ones work, what index funds and exchange traded funds do, and the trade-offs to weigh before you start. It is educational information rather than a recommendation to buy any particular product.
A share market index is just a list of companies measured together to represent part of the market. When you hear that "the market was up today," it usually means an index rose. The S&P/ASX 200, for example, tracks roughly the 200 largest companies listed on the Australian Securities Exchange. An index fund or index exchange traded fund (ETF) is a single investment that aims to hold those same companies in the same proportions, so its return broadly mirrors the index. The Australian Securities Exchange explains the structure of these products on its ETF education pages.
Most Australian index investors come across three indices early on. The differences are smaller than they first appear, because all three are weighted by company size, meaning the biggest companies have the biggest influence on the result.
| Index | What it tracks | Typical use |
|---|---|---|
| S&P/ASX 200 | Around the 200 largest companies on the ASX | Core Australian share exposure |
| S&P/ASX 300 | Around 300 companies, adding more smaller firms | Slightly broader Australian exposure |
| S&P 500 | Around 500 large United States companies | Global diversification beyond Australia |
One thing worth knowing is that the Australian market is fairly concentrated. A handful of big banks and miners make up a large share of the ASX 200 and ASX 300. That is why many investors add an international index like the S&P 500: it spreads their money across industries and economies that are under-represented at home.
The appeal of index investing rests on a few solid ideas. The first is diversification. Owning a slice of hundreds of companies means no single failure can sink your portfolio. The second is cost. Because an index fund simply tracks a list rather than paying a team to research and trade, ongoing fees are usually low, and in investing, lower costs leave more of the return with you. The third is simplicity. You do not need to analyse company accounts or time the market; you decide how much to invest and how often. The Australian Securities and Investments Commission's Moneysmart guide to ETFs is a useful neutral starting point.
Fees deserve special attention because they are one of the few things you can control. With an index fund you are not paying for someone to try to beat the market, so the management cost is typically modest. Over a long horizon, the difference between a cheap and an expensive fund compounds. A portfolio that quietly loses a larger slice to fees every year can end up materially smaller after a few decades, even if the underlying index performed identically. When comparing funds, the ongoing management fee is one of the clearest points of difference.
Index investing is not a guarantee. When the market falls, your index fund falls with it, because it is designed to track the market rather than protect against losses. Over short periods the value can drop sharply, and there is no rule that says it must recover by any particular date. What index investing removes is the risk that one bad company ruins your result; what it keeps is the risk that the market as a whole has a bad stretch. This is why a long time horizon, regular contributions, and the discipline to avoid panic-selling during downturns tend to matter more than clever selection.
Index investing is the best known form of passive investing. The contrast is active investing, where a fund manager or an individual tries to beat the market by choosing which shares to buy and sell and when. Active management can outperform in any given period, but it costs more, and a large body of research has shown that, after fees, most active funds struggle to consistently beat a simple index over long stretches. That is the core argument for the passive approach: rather than paying more in the hope of beating the market, you accept the market return at a low cost and let time and compounding do the heavy lifting. Neither approach is guaranteed, and some investors blend the two, but the simplicity and low cost of indexing are why it has become a default starting point for many.
If index investing appeals, a measured start tends to work better than a rushed one. That usually means sorting out the basics first: clearing high-interest debt, holding an emergency buffer, and being clear about your time horizon, since money you might need within a few years generally does not belong in shares. From there, many investors favour regular contributions over trying to pick the perfect moment to invest, an approach often called dollar-cost averaging, because it removes the temptation to time the market. Whatever you choose, read the product disclosure material so you understand exactly what an index fund holds and what it charges before committing.
Index funds holding Australian shares generally pass through dividends, and often the franking credits attached to them, to investors. When you eventually sell your units for more than you paid, capital gains tax can apply, although the general 50% CGT discount may reduce the taxable gain on units held longer than 12 months. Tax outcomes depend on your own situation and on whether you invest in your own name, through a trust, or inside super, so it is sensible to confirm the detail with the ATO or a qualified adviser.
Disclaimer: This article is general, educational information and not financial or investment advice. It does not recommend any specific share, fund or product. Investing carries risk, including the loss of capital. Consider the official product disclosure material and the guidance at ASIC's Moneysmart, and seek advice suited to your circumstances.