ISAs and Investment Funds
March 18, 2010
7. Choosing An Index Tracker
Choosing an index tracker is relatively simple. There are four main things to consider:
- which index it tracks
- its charges
- what type of fund it is
- whether to put it in an Individual Savings Account (ISA)
Most UK trackers follow either the FTSE 100 or FTSE All-Share. Both these indices cover shares listed on the London Stock Exchange. The FTSE 100 covers the largest 100 companies by market value, and they make up about 80% of the UK stock market. The All-Share covers around 600 companies and about 98% of the market.
You can also buy trackers that follow European, US or Far East indices. There are even some that track world indices. You can also get funds that track specific sectors like technology, health or telecoms.
It's impossible to predict which of these indices will do best. Many people recommend that you diversify your investments internationally, but a significant percentage of the profits from UK companies comes from abroad anyway. Consequently, a cheap UK tracker following the FTSE 100 or FTSE All-Share is a sensible starting point. However, there is nothing stopping you building up a small collection of different trackers over time.
The lower the better. Most trackers have no initial or exit charge, so you only need to look at their annual charges.
That said, it's better to look at the Total Expense Ratio (TER), which includes all charges levied by a fund, rather than just its 'annual management charge'. For a tracker that invests solely in UK companies, look for a TER of 0.75% or less.
Some trackers have a TER of over 1%, which means that they have a much smaller cost advantage when compared to managed funds, so these are best avoided. For a tracker that follows a non-UK market, however, you might have to pay a little bit extra.
Which type of fund?
We'll look at different types of fund later on in this guide, but it's worth highlighting a few points at this stage. Most index trackers are either unit trusts or OEICs (open-ended investment companies). These are the most popular types of fund. They are priced daily and can be bought direct from a fund manager, or via a discount broker or financial adviser.
Other types of fund worth looking at are investment trusts, such as the Edinburgh UK Tracker (LSE: EUK), and exchange traded funds (ETFs), like the iShares FTSE 100 (LSE: ISF).
These two types of fund are both traded on the stock market and therefore their prices will change continously throughout the trading day. They can be bought via a stock broker.
As a general rule, investment trust and ETF trackers tend to be slightly cheaper than unit trust or OEIC ones, so they are definitely worth considering.
Using an ISA
ISAs protect your investments from both income and capital gains tax. It's often worth putting your tracker fund into an ISA to get this protection because there is usually no extra charge for doing so.
Higher rate taxpayers and those who use their full ISA allowance each year have to most to benefit. But even if you invest as little as £100 a month, several years down the line you could find the tax protection comes in handy.