Today's hottest companies may go off the boil down the track. It's one of the reasons why index funds are continuing to attract investors around the world.

Back in 1976, Steve Jobs and Steve Wozniak formed the Apple Computer Company and shortly afterwards launched the Apple 1 computer.

It was a milestone event in personal computer technology and today, almost 50 years later, Apple Inc. is the world’s biggest listed company with a market capitalisation of almost US$3 trillion.

Another milestone event also happened to occur in 1976 with the launch of the Vanguard 500 Index Fund – the first managed investment fund of its kind.

Instead of just investing in a portfolio of hand-picked companies like other investment funds, the new Vanguard index fund was very different because it invested in every company included in the S&P 500 Index at that time.

It was ground-breaking, because for the first time investors had a simple way of investing in the 500 biggest companies on the United States share market via a single investment fund.

Now, investing in index funds that provide instant exposure to hundreds, and sometimes thousands, of companies at once has become the norm for millions of investors worldwide. On a global basis, index-tracking managed funds and exchange traded funds (ETFs) are managing trillions of dollars in investors’ assets.

An ever-changing investment world

The world has changed a lot over 46 years, and that’s reflected by the companies that now rank as the biggest by their share market value compared with those that held the top places in the mid-1970s.

Top listed companies by market value

What’s clear from the table above is that technology companies now dominate the global share market rankings. In the mid-1970s the rankings were dominated for the most part by oil companies and automotive manufacturers. IBM (International Business Machines) was the sole technology company in the top 10 in 1976.

The companies listed on a share market at any point in time could change over time for a whole range of reasons.

This could be because of mergers and acquisitions, companies being privatised, companies failing, or simply because of industrial evolution.

The make-up of the biggest companies on the Australian share market has also changed markedly since the 1970s.

Instead of predominantly being made up of large mining companies as it was back then, financial institutions now account for five of the 10 largest companies. The top Australian rankings also include several former government-owned entities that have been privatised.

Investors in an index fund will always have an exposure to the companies within the share market index that it tracks.

In Australia for example, the S&P/ASX 300 Index tracks the top 300 companies listed on the Australian Securities Exchange (ASX).

The Vanguard Australian Shares Index Fund (managed fund) and the Vanguard Australian Shares Index ETF (trading as VAS) both invest in all of the companies within S&P/ASX 300 Index.

So, through a single investment, it’s easy to invest in Australia’s 300 biggest companies. The constituents of the ASX top 300 may change over time as companies move in and out of the index based on their prevailing share market value.

That’s the essence of index funds and why they are essentially future-proof – in other words, while there may be changes to the constituents of an index over time, the index itself is perpetual.

Broad diversification

There’s another key benefit to investing in broad index funds, of course, and that’s all about the in-built sector diversification that they provide.

If you invest in a single company, you’re basically only buying into that company’s operations and the particular sector in which it operates.

Investing in a few companies can provide you with some diversification, unless all of those companies are operating in the same market sector.

The Australian share market is broken up into 11 key sectors, 24 different industry groups, 68 industries, and 157 sub-industries.

From an investing point of view, you’d need to invest in 11 separate companies to have an exposure to each of the key share market sectors.

To cover off all the large industry groups, you’d then need to invest in 24 separate companies on the ASX.

You’d need to pay stock brokerage fees on each company investment, which can be very costly.

But, even then, you’d still only have exposure to a handful of companies and some industries.

Alternatively, one investment in a managed index fund or an index ETF investing across the broad Australian market provides easy exposure to many companies operating in many different sectors.

And, if it fits in with your investment strategy, you could repeat the process for other international markets to build a highly diversified global equities portfolio.

Vanguard Smart investing

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