Why Trackers Make Sense

Now we are getting somewhere. We've narrowed down our search to a unit or investment trust. Let's just call them funds for simplicity. So how do you choose one?

Active vs. Passive

Funds can be split into two basic types. There are active or managed funds where the fund manager pick and chooses the shares they want to invest in. Then there are passive funds that merely buy the whole market or a certain section of it. These are known as index trackers because they attempt to track an index. An index measures the overall performance of a group of companies. The best known in the UK is the FTSE 100 or Footsie, which consists of the 100 largest shares on the London Stock Exchange.

Active sounds much more fun doesn't it? We all want to be better than average. But guess what? By definition half of us can and half of us can't. In addition many managed funds spend a lot of their time trying to second guess each other and worrying about their short-term performance. That means they, or rather you, incur a lot more in transaction charges.

In fact studies have shown that over the long term index trackers have generated a better return than 75% of managed funds. The main reason is the lower charges that you pay on trackers. They are also a lot simpler and less time-consuming.

Of course there will always be some funds that do better than trackers. The only trouble is identifying them in advance. Some people claim they can although research has shown that the past performance of a fund is no guide to its future performance. Of course, even if you could identify these funds in advance, we can't all invest in just a few funds.

Find out more about index trackers.