FOOL'S EYE VIEW
Track Your Way To Greater Wealth

By Maynard Paton (TMFMayn)
May 15, 2002

Are you considering contributing to an index tracker? If so, you may have asked yourself the following questions. Here are some Foolish answers to help you on your way.

Are trackers really a good investment? Over the past two years, I'd have been better off putting my money in the building society!

Well, yes. Nobody can deny the performance of the stock market has been disappointing of late. However, don't fall victim to Recent Event Syndrome. People often put undue emphasis on recent events, and in the case of the stock market, wrongly extrapolate inherently short-term trends and themes far into the future.

If you have an investing time horizon that runs into decades, then there's no point worrying about how far the current tech fallout will last. Instead, concentrate on what the stock market -- which represents a wide variety of businesses and industries -- has done over long-term.

Sure, the stock market can be volatile. But over the years, the ups and downs are smoothed out. Since 1918, UK stock market has beaten cash and government bonds during:

* at least 75% of all 5-year periods;
* at least 90% of all 10-year periods, and;
* at least 98% of all 20-year periods.

Remember, those saving for retirement via the stock market in the past have had to contend with the Great Depression, the Second World War, three-day weeks, the Cold War, Black Monday, the Gulf War, the Russian debt crisis, and a whole load of other worrying events. And also remember that the vast majority of those stock market savers still came out well ahead of the building society! (For an explanation of why trackers beat the building society, read this.)

Should I start 'tracking' now, or should I wait until the stock market has improved?

Unless you think the global economy is going to stagnate over time and industries such as oil, banking and pharmaceuticals will see their fortunes decline, then the sooner you start contributing, the better. It's all to do with the Miracle of Compound Returns. You see, it's time in the market that counts, not timing the market.

Unfortunately, nobody has ever developed a reliable way of dipping into and out of the stock market at the appropriate time. Generally speaking, waiting for the stock market to 'improve' usually means investing at a higher level some time down the road.

If you want a stress-free investing life (which is why you're looking at trackers, right?), just make regular contributions and forget all about market valuations, the outlook for interest rates and all the rest. Such ignorance will give you an opportunity to weed the back garden, decorate the spare room and clear out the loft, all of which will be more productive than tring to 'time' your contributions.

There are many types of trackers on offer. Which type do I choose?

FTSE 100, FTSE 350 or FTSE All-Share? Generally, it doesn't make much difference. For instance, over the past ten years, the FTSE 100 index has risen 95.70%, the FTSE 350 has increased 97.63% and the FTSE All-Share has improved 95.64%. The main reason for the similar performances is that the top 100 UK companies represent around 80% of the stock market's total value. So whichever domestic tracker you pick, you're still going to be heavily reliant on the same blue chip heavyweights.

Furthermore, you don't really need to venture beyond these shores when looking for your tracker. While promoters will tell you to spread your risk over various geographies (to sell you more expensive products), there's already heaps of exposure to foreign economies from UK-listed companies. 

Just how important are things like charges and tracking errors?

Charges are important. Even though index trackers are traditionally seen as low cost, notable differences do exist. A cursory check of a few trackers highlighted annual management fees of between 0.25% and 1%. Okay, so 0.75% doesn't sound much, but if the stock market generates a 7% annual return in the future, then an additional 0.75% fee will remove a fair chunk of your gains. (Find out how low charges can improve your investment returns here.)

Less important are tracking errors. This study shows how a spread of different trackers has collectively underperformed their appropriate benchmarks by around 0.5%. If you consider management charges are included in this underperformance, then tracking errors are likely to be relatively immaterial. (In fact, some trackers have actually outperformed the index they're following!) Unfortunately, some tracker providers don't reveal their tracking errors, and as yet, there's no helpful website that has deduced how far all individual trackers have diverged from their benchmark.

Summary

Overall, it's worth putting charges, tracking errors, choosing which index to follow and when to start contributing into perspective. Whatever tracker you go with and whenever you start investing, only luck will see you come out with the optimum investment result. But so what? Over the long run, the ordinary tracker investor will still get a decent relative return. Furthermore, he or she will outrun most of the investment alternatives, those being managed funds, DIY stock picking and the building society.

Learn More About Index Trackers: Visit The Motley Fool's Index Tracker Centre