Index Trackers

willsm909

I was recommended the Motley Fools Guide to investing, and they rave about the miracle of compounding by use of Index Tracker Funds.

My understanding is that they tracker the top movers and shakers in the FTSE 100 across all Industries.

I am considering starting to pay into two funds; one for my retirement and the other for my sons education.

Can anyone shed any light on whether they are a sound, money making investment, or should be avoided at all costs.

Your feed back is much appreciated

carnet

Views are split (to say the least ) on passive Index Trackers.

Some (like the MF) swear by them, others (like me) wouldn't touch them with a 10 foot pole.

Depends whether or not you just wish to match the relevant indices, as trackers, by their very nature, will never outperform them (and because of their, albeit relatively low, charges will virtually always just underperform.

I think it also very much depends on your investing experience. The more you have, the less likely you are to invest in trackers.

However, if I was to invest in one tracking the UK I'd always go for an All-Share rather than a FTSE 100 flavour as the latter is too top heavy with a handful of sectors such as oils, banks and telecoms - and therefore riskier.

gizmoleeds

carnet wrote:

Depends whether or not you just wish to match the relevant indices, as trackers, by their very nature, will never outperform them (and because of their, albeit relatively low, charges will virtually always just underperform.

The Motley Fool's view, which they have a lot of evidence to back up, is that the majority of funds must underperform - and this is not opinion, it is mathematical fact.

So, an index tracker will therefore outperform the majority of funds.

dunstonh

The Motley Fool's view, which they have a lot of evidence to back up, is that the majority of funds must underperform - and this is not opinion, it is mathematical fact.

They use a time period that has FTSE100 trackers outperforming managed funds. There are just as many alternative time periods where managed funds have outperformed FTSE100 trackers.

Also, you have to compare like for like.

So, an index tracker will therefore outperform the majority of funds.

Rubbish. You have to compare like for like. A low risk corporate bond fund, gilts or commerical property fund has far lower volatility and over the last 5 years would have outperformed a FTSE 100 tracker.

If you want similar fund coverage, then we could point to the UK equity income sector which has been beating the FTSE trackers for many years now.

Its like comparing apples and oranges. Anyone putting their money into one fund and it being a FTSE100 tracker needs their head testing.

As a side note, research has been done which shows that if you have picked funds across the different sectors and only achieved average performance, you would still have beaten the top performing stockmarket funds (which are managed funds btw) over the same period that MF say trackers are best. Throw in some annual rebalancing into it and you would have got even more.

hobbesandco

I started investing three years ago and the first step I took was to mimic the world's greatest investor Warren Buffett. His mentor is Ben Graham who has written several books (in the 1930's although the principles apply to this day). For those who are just starting out, he advises investing in index trackers because the charges are low (much lower than mutual funds) and because of this they will perform better than the vast majority of mutual funds. He also advises drip-feeding money each month so you're not timing the market (and let's face it very few people have the skill to do it). There was also a good study done (I think by Joel Siegel recently) who said someone who started investing in 1929 (just at the height of the stock market before its crash) and kept on investing (with dividends reinvested) right through the crash would still have made a 6% return. The moral of the story: he advises reinvesting your dividends. So to recap, their advice is to start with an index tracker, invest a set amount per month and reinvest dividends.

Now someone previously said the more experience you have, the less likely you are to invest in an index tracker. I think Ben Graham would change that advice slightly such that the more experienced investor would expand on his/her core holdings of index trackers by researching stocks and finding companies whose market valuation is below its 'instrinsic' value.

It really is down to what you feel comfortable with. I would suggest doing as much research as you possibly can and not taking anyone's advice at face value without checking out the facts and finding out what they've got to sell you! Read as much as you can, follow what the best investors are doing (even if they have vastly different strategies), select a strategy you feel comfortable with and always be willing to learn and be flexible. Most importantly, set realistic expectations too.

Look at up-front costs, annual management costs, 'hidden' costs, transfer costs, tax implications etc. of any product being sold to you. Also, beware of those who compare trackers vs. funds over 5 years or so. Lies, damn lies and statistics comes to mind. When comparing, compare over the duration of your investment lifetime. Got 25 years? That's what you should be comparing. Not 5 years. Mutual funds beat trackers? Not if an equity income fund charges 5% up front and a 1.5% amc. Will the same fund beat trackers in the next 5 years? Not likely if the star manager has just moved to start his own company. Good luck!

gizmoleeds

dunstonh wrote:

They use a time period that has FTSE100 trackers outperforming managed funds. There are just as many alternative time periods where managed funds have outperformed FTSE100 trackers.

I don't want to argue as you may well be right (I don't know a lot about investments), but my Motley Fool book uses 1900 to 2000 as a comparison.

Also, the index is effectively the average performance of all stockbrokers. And the majority of them cannot outperform the average of their own performance - it is just not possible. And as they make more trades then an index tracking fund they will have higher costs eating into their fund too.

carnet

gizmoleeds wrote:

So, an index tracker will therefore outperform the majority of funds.

Yes, but with 20 years fund investment experience I do not invest in the "majority" of funds. I invest in those which my research identifies as being in the most promising sectors/geographical area(s)/asset classes, with the investment objectives/portfolio freedom I'm looking for, being of the optimum size etc. etc. going forward,- and, most importantly, run by who I consider to be the best managers in their sectors.

If I couldn't beat the relevant indices by some considerable margin over, say, any rolling 3 year period, I would give up investing tomorrow.

From The Motley Fool;

“Index trackers beat 3 out of 4 managed funds over the long term (5 years or more). This is primarily due to the fact that their charges are lower. But if you want to beat the index then you will need to choose a managed fund although bear in mind the odds of beating the index are against you.

All else being equal, and it usually is, a low cost fund will tend to perform better than a high cost one. Some funds charge up to 5% in initial fees and 1.5% or more in annual fees. As a group, investment trusts tend to have lower charges than unit trusts, although their performance tends to be more volatile.

It's easy to assume that the odd 1% here and there doesn't make much difference. But this is definitely not the case. A fund that grows at 10% a year for 20 years will give you 24% more as a final sum than a fund that grows at just 8.5%. Initial charges can quickly take their toll, especially if you tend to switch funds every few years.”

However, by implication, 25% of managed funds do outperform the indices/trackers. As Hargreaves Lansdown recently put it;

“ Poor performing funds can really hurt the performance of your portfolio. A mere 2% annual underperformance could cost you over £5,000 on a £17,000 portfolio over 10 years*

· Over 10 years the difference would be £5,750. This is for illustration purposes only and assumes 5% growth versus 7% growth.”

Therefore, a £17.000 portfolio will, by picking a fund or funds which increases at 7% p.a. rather than 5% p.a., return an extra 20% over 10 years - or over 45% over 20 years.

hobbesandco

Carnet, as you have numerous years of investment experience and you obviously feel confident enough to select mutual funds in various sectors, do you invest directly in stocks as well or do you just stick with mutual funds? Also, what would you do if the fund manager left for another company? Would you transfer your holdings to the new company and face exit fees? I understand what you're trying to say and for a more experienced investor I can see the need for mutual funds (particularly Fidelity Magellan in the 80's) BUT I am having a difficult time trying to explain why I should fork out 5% on front-load fees and 1.5% AMC for the vast majority of funds which don't hold up well against trackers. Is it a case of doing lots of research and hoping for the best?

dunstonh

Its not about picking the best funds. Its about picking the right sectors.

BUT I am having a difficult time trying to explain why I should fork out 5% on front-load fees and 1.5% AMC for the vast majority of funds

Who says you have to pay 5% initial charges? You clearly are not buying your investments from the right place.

However, too much focus is made on charges. I would rather pay 0.5% extra a year for 20% extra growth potential.

I don't want to argue as you may well be right (I don't know a lot about investments), but my Motley Fool book uses 1900 to 2000 as a comparison.

And clearly we will all be investing for 100 years!!!!

If you want low volatile funds, you pick lower risk funds. These dont offer the potential big growth but they bring in relatively steady returns. These will never out perform FTSE trackers over the long term. However, they are not designed to.

Trackers are limited by the index they are tracking. They have no downside protection. This means they are very good when things are going up but not as good when things are going down. In these days of more volatile markets, income has been the main driver behind UK returns. Are these trends likely to continue? Does any event in the last 100 years match the current situation? So can you compare performance then with now?

The UK is generally the top performing sector once every 5-7 years. So, stick it in a FTSE100 tracker and you will be lucky twice, maybe three times over 15 years. The rest of the time, another sector will be peforming better.

carnet

hobbesandco wrote:

Carnet, as you have numerous years of investment experience and you obviously feel confident enough to select mutual funds in various sectors, do you invest directly in stocks as well or do you just stick with mutual funds? Also, what would you do if the fund manager left for another company? Would you transfer your holdings to the new company and face exit fees? I understand what you're trying to say and for a more experienced investor I can see the need for mutual funds (particularly Fidelity Magellan in the 80's) BUT I am having a difficult time trying to explain why I should fork out 5% on front-load fees and 1.5% AMC for the vast majority of funds which don't hold up well against trackers. Is it a case of doing lots of research and hoping for the best?

Yes, I also invest in individual shares inc. IT's but my "specialist subject" is fund investing.

Following the fund manager is, IMHO, much more valuable than following any particular fund, on the basis that any fund is only as good as the stock picking expertise of its manager. If one of my "designated" managers departs for another house my first instinct is usually to sell the fund and move on either to his/her new fund or to another one altogether - but it all depends on individual circumstances - sometimes an equally good and (very occasionally) an even better manager (IMHO) takes over - see Schroder European Alpha Plus as a recent example.

You don't have to pay an IC of circa 5% if you go through one of the many discount brokers where the typical IC is 0.5% or even less. Switching within a supermarket typically costs only 0.25%.

dawny10

One (possibly daft) question about trackers - what happens with dividends?