There’s a lot to be said for keeping things simple when it comes to investing. It’s one of the reasons index trackers provide an excellent way to invest in the stock market.
Perhaps the thing I like most about index trackers is their simplicity when compared to other forms of investment. As we’ve discovered in the past eighteen months, many complicated investment strategies offer little transparency and even less in the way of protection when times get tough.
With an index tracker, all you are essentially trying to do is capture the return of a particular stock market for as little cost as possible. Choosing a fund is simple as there only a few factors to consider. It’s also easy to invest your money and monitor its progress.
Choosing an index tracker
Trustnet lists almost 3,000 unit and investment trusts and nearly 7,000 funds that you can put into a pension. How on earth does the novice investor know where to start when choosing a fund?
With index trackers, the process is much simpler. You choose which market you want to track and then pick one of the lowest-cost funds which follow that market.
Most investors will want to start with a fund tracking the UK market. Here index trackers will either follow the FTSE All-Share index or its more famous younger brother the FTSE 100. There’s not a lot to choose between the two although I slightly favour the former as it captures a larger percentage of the market (98% versus around 80%-85%).
Then you look for a fund that has a low total expense ratio. Most funds tracking the UK market fall between 0.3% and 0.75% so look for something in the bottom half of that range. You might find this article from last June a useful starting point - it lists the ten cheapest UK trackers at that time and has a brief introduction to the different types of fund. This follow-up piece lists looks at trackers following overseas markets.
Investing in an index tracker
Putting your money in an index tracker is also very simple. Exactly how you do it will depend on the type of fund you end up choosing.
If it’s a unit trust, OEIC or investment trust then it should have a savings scheme that will you allow to invest from as little as £10 a month or from £250 as a lump sum. The minimum amounts vary between funds, with the combination of £50 a month and £500 for lump sums being the most typical.
If you choose an exchange traded fund like an iShare then you can use a service like the Motley Fool’s ShareBuilder to make cheap, regular purchases.
When it comes to index trackers, I reckon regular investing is the place to start. It eases you into the process of investing and then, when you have a bit more confidence, you can look to invest more money with a lump sum.
Regular investing also removes the need to make a decision on whether now is a good time to invest or not. Nobody knows what the market will do next week, next month or next year and it’s pretty pointless agonising over it as a novice investor. I’m a great believer in the old saying that to be a successful investor, it’s time in the market that’s important and not timing.
Reinvesting your dividends and keeping your investments safe from the taxman by putting them in an ISA also makes a lot of sense. Many funds will allow you do both of these without incurring any additional costs.
As with all types of investment you want to diversify, so I reckon it’s a good idea to build up a portfolio of, say, four different index trackers over time. Two of these could follow the UK market and two could invest overseas. This gives you a solid base on which to add other funds and shares when you become a more experienced investor and feel comfortable taking on a bit more risk.
Following your index tracker
If you invest in managed funds or shares, you need to keep monitoring them to see how they are performing. You may want to ditch some and replace them with others. This can take time and quite a lot of it too. You also incur transaction costs which reduce your overall returns.
With an index tracker you don’t have these concerns. You know its performance should closely match the index it’s attempting to follow and it’s pretty easy to check that this is indeed the case.
There will be some differences, mostly due to the annual cost of the fund but also due to what is known as tracking error (as no fund can precisely match the index). You can also compare your trackers against others tracking the same index with a similar cost structure to ensure your fund is up to scratch.
Find out more in the Fool’s index tracker centre
