How do trackers work and what are the risks?

carl916

Hi,

I'm looking to invest around £100 per month into an index tracker, probably the FTSE All Shares index tracker from Fidelity; and maybe something outside the UK in the future. The target investment period would be 10+ years.

Could someone please explain how the purchase and retention of shares works with index trackers?

Could someone also explain the risk involved with this type of product? I've read that the risk level for this type of product is medium to high. My understanding is that if I invest regularly over a long period of time, any drops in the market can only work in my favour unless I decide to sell before the shares recover. Once shares have been purchased, are they retained in that company by the tracker or could the tracker sell these at some point in the future to buy shares in another company? The point I'm trying to understand is that if the shares are retained indefinitely then the biggest risks are either the share price never recovers or the company in which the shares are held folds.

Many thanks

Carl Gilbert

SeanW

They work by holding shares or securities that represent the index, so that up and down movements in the index will be reflected by the value of the fund. They will sell and buy these as necessary to reflect the index they are tracking, and the amount of money coming in or out of the fund.

Investing monthly can help because when units are low, you are buying more, and averaging out the value you have paid for each unit. I'm not sure I understand what you mean that if it falls its in your favour, because your other units are now worth less than you paid, there are no guarantees that even in 10 or 20 years they will recover, or you wont need to sell during a bad time.

The risks of only investing in a single tracker fund, such as FTSE 100 tracker, is that your exposure to investment sectors is restricted, e.g. just the UK top 100 companies (by capitalisation).

gozomark

its not the biggest UK companies, but the biggest companies listed in the UK, which includes alot of foreign companies

Blah99

gozomark wrote: »

its not the biggest UK companies, but the biggest companies listed in the UK, which includes alot of foreign companies

Very, very important point, this. Lots of foreign companies in the ftse100, especially the miners like Kazakhmys.

StevieJ

Blah99 wrote: »

Very, very important point, this. Lots of foreign companies in the ftse100, especially the miners like Kazakhmys.

They reckon that foreign sales of companies in FT100 is between 60-70%, provides some diversification though.

LongTermLurker

OP is on about FTSE all share though, which is at least a broader choice.

The main risk of trackers as I see it is that they have to follow the index they're tracking - over a cliff if need be! So when the dotcom bubble burst, they had no way to avoid it - they couldn't just say "I can see this is climbing to an unsustainable level, I think I'll sell and take a profit while the going's good".

Same goes for the banking crash and the commodities drop. Much of the work is done by a computer and humans play little or no part in the process.

Apart from that, all the usual risks of the stock market also apply - currency exchange rates, companies going under, companies going out of favour, etc etc.