Picking a cheap index tracker is not always straightforward.
Index trackers are very rightly popular with smart investors. At a bargain price, they offer a compelling combination of stock market returns and effortless diversification.
And very rightly, too, many investors have become focused on making sure that they are indeed paying that bargain price. Thanks to its insistence on continuing to levy a now-expensive 1% annual charge, for example, Virgin's once market-leading product has been eclipsed by Legal & General's (LSE: LGEN) popular UK Index FTSE All-Share tracker, which has annual management charge of just 0.5%.
And many investors, too, know that they have to look beyond that simple annual charge, and compare providers' Total Expense Ratio (TER) -- the 'all in' cost figure. This, of course, is the figure we tend to use when writing about trackers here on The Motley Fool.
But as investors have got cannier, providers have got wilier. Here are three tracker mistakes that can seriously sap your wealth.
'Bait and switch'
When mighty US fund provider Vanguard at long last entered with UK market with a range of long-awaited low-cost trackers, a shake-up in the charges levied by other providers was widely expected.
HSBC (LSE: HSBA) didn't take long to respond, cutting charges across a range of tracker products. The annual charge on its HSBC FTSE All-Share Index Fund, for instance, was slashed to just 0.25%, equivalent to a TER of 0.27% -- a move that quickly attracted market attention. Start comparing low-cost trackers, and you'll soon spot HSBC's offering, something that would have been unthinkable a year ago.
But walk into your local HSBC branch, and the FTSE All-Share tracker they'll try to sell you is an entirely different animal. For a start, there's a whopping 4% upfront charge. That's right: for every £100 you invest, only £96 gets put to work. Yikes. Plus, on your way out of the door, they drain your life-blood out, and sell your daughters into slavery. (OK, I made that bit up, but you get the idea....)
Buy via HSBC's website, and a 'special offer' reduces this wealth-sapping charge to 'just' 1%. Big deal. And in both cases, there's an annual management charge of 0.5%. Either way, it's a poor proposition, and one that investors shouldn't touch with a bargepole.
To get the real low-cost tracker deal, you'll need to invest via one of the popular fund supermarkets. In the case of the FTSE All-Share index, for example, the fund you're looking for will probably have the all-important word 'institutional' added to the name. But to be sure, check the listed charges first: a good fund supermarket will make the TER abundantly clear.
All TERs aren't equal
In the vast majority of cases, the difference between a tracker's annual management charge and its TER is tiny. As we've just seen, HSBC FTSE All Share tracker's annual charge of 0.25% equates to a TER of 0.27%, while the 0.5% annual fee on Legal & General's UK Index FTSE All-Share tracker works out at a TER of just 0.52%.
Investors, rightly, could be forgiven that a low management charge automatically means a low TER. But they'd be wrong. Fidelity, for instance, trumpets that the annual management charge on its popular Fidelity MoneyBuilder UK Index is a market-leading 0.1% -- and I, for one, certainly haven't found a cheaper offering anywhere else.
But the TER on the Fidelity tracker isn't the 0.12% or thereabouts that might be expected. Instead, it's 0.3%, an altogether less attractive deal. What's more, Fidelity have recently increased it: the TER used to be 0.27%.
The Fidelity product is still a good one, in my view, and the TER of 0.3% still makes it one of the lowest-cost offerings on the market. But it's not quite the deal that Fidelity make it out to be: their marketing literature brags about the low management charge of 0.1%, and you have to dig deeper to discover the TER.
"Firms aren't obliged to disclose their TER," warns Christopher Traulsen, director of fund research at Morningstar. "Look at many of their fact sheets, and you'll see low annual charges, but no mention of the TER." By law, he explains, it must be printed in the 'simplified prospectus' that firms must provide -- but needn't be specified elsewhere.
The Vanguard complication
While Vanguard have been lauded for finally entering the UK market, their arrival has complicated the calculations that investors must perform.
Vanguard's annual charge on its FTSE All-Share tracker is a very attractive 0.15% -- not quite as good a deal as Fidelity's, but still pretty darn cheap. But -- and here's the rub, pay attention -- its TER is also 0.15%, a feat achieved by levying a one-off upfront charge of 0.5%, in order to cover fund costs such as stamp duty.
As common sense -- and Morningstar's Christopher Traulsen -- will tell you, that means that the Vanguard fund isn't for short-term switchers. So if you think that you'll switch out of the Vanguard fund after a few years, offerings such as the HSBC fund are cheaper.
On the other hand, if you're content to leave your money with Vanguard, then the Vanguard deal is the cheapest going -- and hopefully will remain so. Vanguard themselves make the same point on their website, pointing out that their charging structure is designed to reward long-term buy-and-hold investors.
As it turns out, having weighed up the various offerings on the market, I'm about to switch one of my own FTSE All-Share tracker investments into Vanguard's offering.
In order to bypass Vanguard's minimum investment of £100,000 (yikes), I'll be doing so via one of the small-but-growing number of fund supermarkets that offer the Vanguard product -- and I'll hopefully I'll be leaving it there for at least ten years or so.
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> Malcolm Wheatley holds the HSBC FTSE All-Share tracker within his SIPP, while his delightful wife Mandy holds the Legal & General UK Index tracker within her ISA and SIPP.