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This article continues a our series on ISAs and investment funds. Choosing an index tracker is relatively simple. There are four main things to consider: 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. The All-Share covers the top 700 or so. 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. Trackers that follow other indices tend to be more expensive. However, there is nothing stopping you having a small collection of different trackers, perhaps a different one each year. Charges The lower the better. Most trackers have no initial or exit charge, so you only need to look at 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'. As a rough guide, for a UK tracker 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 a managed fund. For a tracker that follows a non-UK market you might have to pay a little bit extra. 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. Other types of fund worth looking at investment trusts, such as Edinburgh UK Tracker (LSE: EUK) and exchange traded funds (ETFs), like the iShares FTSE 100 (LSE: ISF). These 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 The simple answer to this is "almost certainly yes!" Index trackers generally charge you the same whether you buy them inside or outside an Individual Savings Account (ISA). So there's no downside to being in an ISA and you might as well be safe rather than sorry. What's at stake is the capital gains tax on any gains that your tracker makes over the years. You get an annual exemption from capital gains tax, currently £8,200 per year, but if you're investing for the long term, then you'll hope to make gains eventually that exceed this. Of course, the more you put into the index tracker each year, the more likely it is that capital gains tax will eventually become an issue. But, if it costs nothing extra to use an ISA wrapper then, as we've said, you might as well. Higher rate taxpayers will also benefit from not having to pay additional tax on dividends that they receive in an ISA. There are a couple of situations that might depart from this. First of all, if you're saving for retirement, then it might be better to wrap your index tracker up in a stakeholder pension. These have some problems of their own, but they're designed to give you a retirement income safely and, if that's your aim, then there's a lot to be said for them. There's more about the pros and cons in the Pension Centre. Another reason for shunning an ISA for your index tracker is if you do actually go for one that costs more to have wrapped in an ISA than it does to buy separately. This might be the case for index trackers that are structured as investment trusts or exchange traded funds (eg 'iShares'). However, there are brokers that provide specialised ISAs to house these products and the small extra cost is most likely worth it to avoid the risk of capital gains tax down the line. If you do decide to go for an ISA, then the first thing to decide is whether you want to go for a 'Mini' or a 'Maxi'. A 'Maxi' can take up to the full £7,000 annual allowance and all of it can go into stocks and shares (which would include an index tracker), should you wish, but only up to £3,000 is allowed to be held as cash savings. Alternatively, you could go for 'Minis', where you have separate ISAs, through separate providers, for the cash and shares bits. If you go the 'Mini' route, then you can put up to £3,000 into one 'cash Mini-ISA' and up to £4,000 into one 'stocks and shares Mini-ISA'. So, if you think you'll be investing more than £4,000 this year into your index tracker, then you'll need to put it in a 'Maxi-ISA'. If, on the other hand, you'll be investing less than £4,000 this year into the index tracker, or you really want a 'cash-ISA' as well, then you'll be best to put the tracker in a Mini-ISA, leaving you the scope to put up to £3,000 in a separate 'cash Mini-ISA'. There's more about all this in the Cash ISA Centre. In the next article we'll look, in detail, at how an index tracker actually works.