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Index-tracking funds: the easy way to invest in the stock market

Index-tracking funds: the easy way to invest in the stock market

This is the easy, cheap and non-frightening way to invest in the stock market…and it works! Index-tracking funds (also known as ‘trackers’) are a no-fuss way of putting your money into the stock market (for the long-term remember) and making decent money over time. Here’s what they are and how you can start investing today.

What are index-tracking funds?

Tracker funds ‘track’ a particular stock market index (i.e. defined group of companies such as the largest 100) by investing some of your money in every single company in that index. This means that as the index goes up or down (depending on how the shares of each of the companies in the index do each day), your investment goes up and down with it.

There are various ‘indices’ in Britain and around the world that are ‘tracked’ by tracker funds. For example, the ‘FTSE 100′ (the index you keep hearing about in the news) is made up of the 100 biggest companies that have shares available to buy and sell on the London Stock Exchange (LSE) that’s where those shares are ‘listed’.

When a company gets ‘listed’ on a stock market it means that at least part of it has been sold to the public (i.e. you, me or anyone else who wants to buy those shares) rather than being privately owned.

In other words, lots of people can own a little bit of each company by buying one or more bits/‘shares’ of it. Once a company is listed it can only become a ‘private’ company again if it buys back all of the shares or if another company or group of people does so and thereby ‘de-lists’ the company – this is what Richard Branson did with his company, Virgin.

If you are considering investing in a tracker fund or two, another index you should be familiar with is the FTSE All-Share, which represents the vast majority of companies that are listed on the London Stock Exchange (over 700 of them).

There’s also nothing to stop you investing in a fund that tracks one of the many other indices, such as AIM (Alternative listings for smaller companies  in the UK), the Dow Jones or the Nasdaq in America, the Nikkei in Japan, the Hang Seng in Hong Kong or the DAX in Germany – in fact I suggest that in time you should spread your money across different countries and sectors – but to start with, stick to British funds where you know where you are and you have easier access to information about them.

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The different types of indices to track

There are three main British indices that you can choose to ‘track’. The FTSE 100 and the FTSE All-Share tend to perform pretty similarly, but the third, the FTSE 250, goes up and down a little more because it’s made up of middle-sized companies, for which the prices can be a bit more volatile.

The FTSE 100 – This measures the largest 100 companies in the UK by value. One current example is BP, which is UK-based, but operates internationally.

The top 100 companies represent about 80% of the value of the whole of the London-based market (the FTSE All-Share), so you can get a pretty good idea of what the stock market as a whole is doing from how these top 100 companies are performing. This is why they report on the FTSE 100 in the news – if the FTSE 100 is up a few points then the overall feeling is positive – companies are generally perceived to be doing well.

The FTSE 250 – The next 250 biggest companies in size are known as the FTSE 250 – in other words, the companies ranked 101 to 350 in the market. Companies in this index are generally known as the ‘mid-caps’, meaning that they have a capitalisation (what they would be worth if you sold them) that is somewhere in the middle between the FTSE 100 and all the other tiddly little companies that are listed.

Interestingly, many of the traditionally ‘British’ companies, like manufacturers and house-building companies, are often found in the FTSE 250. For that reason, investors often choose to track this index if they believe the next few years will be bright for the British economy. They’ll look for signals such as a falling unemployment rate, which means more people are holding down jobs and able to spend more on housing, travel and shopping.

The FTSE All-Share – This measures how the major part of the companies (around 700 of them) listed on the London Stock Exchange is doing. This includes each one that sells shares to the public, from the very big household names like BT to the tiddlers, such as estate agents. Although it includes all of the publicly listed companies in the country it moves up and down in a similar way to the FTSE 100 because the first hundred companies in the index account for the vast majority of the wealth of the whole lot.

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Will I make money?

Probably, but it’s not guaranteed. Over the last 100 years the FTSE has gone up and people who invested directly into the market and left their money there for years have certainly seen it grow. However, as the adverts always say, past performance is no guarantee of future growth, so keep that in mind.

It is likely that the FTSE will continue to grow over the years, albeit in the up and down, rollercoaster way that it always does, and a Tracker is a good, clean, cheap and easy way of getting a piece of that growth.

If you invest in a FTSE 100 index-tracking fund, your money will be spread over all one hundred companies in this index. This means that you will be investing in at least 100 companies all in one go, though you will have a different amount in each one.

In Britain there are funds that track the FTSE All-share, the FTSE 100, the FTSE 250 and the FTSE Tech Mark among others. If you put your money into one of these funds your investment will go up and down pretty much in the same way that the index goes up and down.

Over time though, the net effect has been that these funds have gone up. Historically the stock market has always gone upwards, though in a very bumpy way. Sometimes it will go down for a few years but then it will go up again for a few more years. So if you leave your money in one of these funds for long enough (at least ten years I think) you can be pretty confident that it will generally go up. After all, that is what it has done for the last hundred years or so.

Trackers charge less than the managed funds because they’re run by computers which, unlike your average City fund manager, don’t expect a new Porsche Boxter and a holiday in the Bahamas every year. In fact, you shouldn’t pay more than 1% a year in management fees for your index-tracker, and some charge less than 0.5%. Index-tracking funds are relatively easy to invest in. The only hard part is choosing which one.

How do I invest in a tracker fund?

It’s very simple to invest in an index-tracking fund. Go to one of the companies that offers tracker funds such as Legal & General, Scottish Widows, Virgin, Fidelity or M&G. Go to their tracker fund section and pick one you like (perhaps a UK 100 Index or aFTSE All Share) and then start the application process. You will need your National Insurance number and your bank details but otherwise it’s pretty straightforward.

You can even just call them up on the phone, say you want to invest money in one of their tracker funds and follow their instructions over the phone.

It’s important to remember that whichever fund you invest in, it’s a gamble as to whether you will make a good return or not. However as we said, as long as you are in it for the long run you should make some money on your investment.

ISA allowance

You also get an option to have some or all of your investment wrapped in a tax-saving ISA. This is a good thing to do if you haven’t already used up your stocks and shares ISA allowance. Many companies that provide tracker funds also offer them pre-wrapped in an ISA which makes it easier. Legal & General, for example, offer their impressive fund already wrapped in an ISA.

If you don’t want to put all your money into a stocks and shares-based ISA you can just put some in a mini shares ISA and the rest in a mini cash ISA (remember you cannot put more than half the allowance in a cash ISA). You will also be asked if you would like to put in just a lump sum or make regular monthly investments.

It depends on your circumstances what you do here. If you have a lump of money to invest now then go ahead and put it in. But if you don’t, and you think you can afford a certain amount each month, then set that up as a direct debit from your bank account.

You could also set up an ISA wrapper of your own into which you put a tracker fund and some other investments, depending on what interests you. 

Sitting on your investment

Once you finish the application you will be sent paper forms to fill in and you will probably need to show that you are who you say you are (annoying anti-money-laundering legislation insists on that). That will mean sending some household bills or similar, which they will send back.

Once you have invested your money in a tracker fund you can pretty much forget about it apart from when you get a report on your investment from the company – usually twice a year. Some years your money will have increased, other years it will go have gone down, depending on how the index itself did that year.

Remember, you need to have your money in that investment for at least five years, ideally ten, to get any real benefit from it. Over the long-term these funds have historically gone up, even though at times it looked shaky!

See below for a list of some of the companies that offer index-tracking funds. They’re all easy to invest with and all are good names. When it comes to choosing which company to go with there’s not a lot to choose between them really. The annual charges are the main thing to consider; just go for the cheapest on the whole.

Also, it’s a good idea to mix and match as the years go on. Put some money in one of them one year, then try another one the next year and so on. After a while you could also be adventurous and try funds that track foreign indices. There – you’re investing in the stock market. That wasn’t hard was it?!

handlisas
  • http://www.theshoestringinvestor.com/about The Shoestring Investor

    I learnt recently that well over half of managed funds fail to beat the index. It’s incredible that we pay all those big fees to get a substandard product! I don’t know if tracker funds are the long term solution but they’re certainly more appealing than a managed option.

  • Rebecca C

    Hello,
    I am thinking of taking your advice and investing in a FTSE index tracker fund. However, (and I know that these investments take a long view and this won’t be relevant in a few years time), but with the present LIBOR situation about to hit home, and this already having an adverse affect on the UK stock market, would it therefore be safer to invest in a global trust, technology or emerging market abroad at present?
    Or, does it work the other way around and it’s a good time to buy shares now, and hope things improve massively, yielding a larger increase!!? I’m new to all this, so forgive my ignorance!
    Thanks in advance,
    R

  • john

    can tracker funds produce income ie dividends on a regular basis or are they only for growth?

  • Ben

    You mention index trackers, but you don’t offer any link to sites such as smart-beta that give a breakdown of each of the trackers’ performance and volatility.

    Nor do you mention fundamental trackers, such a the Munro fund.

  • Linda

    Most of the links on this page go nowhere so it was not much use to me.

  • Radostina Dencheva

    “There’s also nothing to stop you investing in a fund that tracks one of the many other indices, such as AIM”

    Could you please name one? Thank you!

    • http://www.jasminebirtles.com Jasmine Birtles

      Sure, Legal & General, for example, has index trackers that track the US index, a European index and a Global index. there’s also HSBC Pacific – those are just as examples.

  • Samina

    Hi,

    I wish to choose which company stocks i want to invest in. Can this be done in any way? As an example say if I wanted to invest in Next, can I go to the bank where I hold my tracker fund and tell them that I want to specifically buy some Next shares?

    • http://www.jasminebirtles.com Jasmine Birtles

      Well if you want to buy shares in Next you would need to do this through a stockbroker. You can do it through an online stockbroker (which is the cheapest and easiest option) like TD Waterhouse. You could also do it through your bank if they have a share-dealing service although that will probably be more expensive. If you have a tracker fund then that will ‘track’ a whole range of companies, not just one, so you can’t mix the two types of investing. I’ll do a step-by-step article on how to buy shares in individual companies like Next so that you know.

      • Samina

        That would be really helpful. When is the article likely to be done by so that I can keep an eye out for it? Thanks

  • Ciaran

    Hi
    I heard a lady on the radio yesterday who spoke of this site, and I find this is all really interesting, but how easy is it to close or withdraw from these schemes and would you loose money etc.
    thanks

    • http://www.jasminebirtles.com Jasmine Birtles

      Hi Ciaran, It’s pretty easy to open and close these. You can withdraw your money just by contacting the tracker fund company (either by email or by phone) and asking them to transfer the money into your bank account. Yes you certainly could lose money but you’re less likely to if you leave it in there for several years (ideally 10 or more I think). These are long-term investments and they only really work if you keep them for many years.

      • Ciaran

        thanks, best wishes.

        Ciaran

  • Penny Salma

    Thanks for sharing, I just wanted to let you know that your blog doesnt show up perfectly on the blackberry browser but I am probably still in a minority of users.