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; and
• whether to put it in an Individual Savings Account (ISA).

Which index

Most UK trackers follow 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 700 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.

Charges

The lower the better. Most trackers have no initial or exit charge, so you only need to look at their annual charges.

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 TERs 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 you might have to pay a little bit extra however.

Which type of fund

We'll look at different types of fund later on in this series, 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 via a fund manager or financial adviser.

Other types of fund worth looking at investment trusts, such as Edinburgh UK Tracker (LSE: EUK) and exchange traded funds (ETFs), like iShares FTSE 100 (LSE: ISF). These types of fund are both traded on the stock market and are 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 so they are worthy of consideration.

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 maxi ISA allowance each year (£7,000) 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.

If you like to put some cash into an ISA each year then you can open a mini cash ISA and a mini shares ISA for your tracker. You can put in £3,000 and £4,000 respectively into these ISAs each year.