Dipping my toes into the murky world of investing...

john_s_2

OK, I've been thinking about this for some time. I have enough cash saved for all my expectations over the next three years or so (about a third of my household's gross income). I'm in it for at least the medium term (ie five or so years - longer if my circumstances don't change). I accept that my investment might go down instead of up.

I have no debt other than a mortgage, which is due to be paid off in seven years time. With overpayments that's all on target (it's an endowment mortgage... which is an investment in itself, I know...) I am NOT doing this because of low interest rates on my savings; I've been planning to get into this for some time once I'd built up enough cash savings.

Having read around a bit I'm considering an index tracking ISA. I would probably start off with a lump sum (say £1000?) then drip feed thereafter (say £50+ pcm?)

I don't have a clue where to look for what's available. Obviously I've done a bit of Googling. Given I'm considering an index tracker I'm assuming there can't be that much in it? I realise that some funds will do a better job of tracking its index than another one tracking the same index, and I realise the fees might be different.

For the sake of an example, I found this page on the L&G website:

http://www.legalandgeneral.com/investments/isas/index-tracking-isa/the-charges.html

Finally, my mortgage is on a fixed rate of 6.05% until 2015. So I guess any investments I make would have to return (on average) better than 6% a year over the next seven years to have made them worthwhile compared to overpaying my mortgage (more than I am already). That said, my forecasted overpayments are almost the maximum of 10% each year.

So my questions...

Anything I've not considered? As in, things I should have done / thought about before taking the plunge? Other types of investments that suit a beginner better than an index tracker? Why shouldn't I plunge into one of the L&G ISAs listed above?

Happy to be talked out of this venture... ;-)

Lokolo

Ok a tracker is done my computer not a person and is completely automated. This means lower costs. However obviously you put a computer against a human on the world stock exhange - as long as the humas has knowledge, its likely to do better.

However, because its a computer, lower costs to other funds.

As a beginner then yeh a tracker is fine, however once you get into investing you will find there are a lot of better opputunities - however these come in all sorts of shapes and sizes.

If you want to start now then yeh fine, go for the index tracker - you can always go into another fund at a later date. However if you want to wait 6 months, in this time you could most probably teach yourself the basics of investing and put yourself in a deeper pool as such.

john_s_2

Thanks for that. From what I've read (eg Motley Fool) managed funds have two disadvantages: 1. a lot of them do worse than the sector they're in (ie they might as well have just tracked it); 2. as you point out, because they're managed, the fees are higher.

The way I see it, I'd be gambling straight away in the sense that if I go for a managed fund I'd be attempting to back a 'winner' instead of a 'loser'. I can take that element of risk out of it by going for a tracker. (I'm fairly cautious, can you tell? ;-)

Aegis

john_s wrote: »

Thanks for that. From what I've read (eg Motley Fool) managed funds have two disadvantages: 1. a lot of them do worse than the sector they're in (ie they might as well have just tracked it); 2. as you point out, because they're managed, the fees are higher.

The way I see it, I'd be gambling straight away in the sense that if I go for a managed fund I'd be attempting to back a 'winner' instead of a 'loser'. I can take that element of risk out of it by going for a tracker. (I'm fairly cautious, can you tell? ;-)

If you're cautious then you should be aware that in the same sector a managed fund will generally come out as less risky than a tracker because of the downside protection present with a good fund manager.

Lokolo

Although I wouldn't mind seeing more data from dunstonh about his table of active vs tracking (its all about L&G rather than whole average which is what I'd like to see) it suggests that trackers don't do as well as active, but it does depend on the provider.

julieq

Just said this in another thread, but I'd be looking at Guaranteed Equity Bonds at the moment.

GEBs were total pants a few years ago, because there was quite a big downside risk (25% in lost interest potentially in comparison to a long term savings rate) against a market that was struggling upwards and looked shaky, but as things are savings interest rates have collapsed and the market is looking low. I think that adds up to value, though I haven't looked at what is available at present.

Investment is about spreading risk and spotting opportunities, not about picking 100% winning bets. You can't call every twist and turn in the economic cycle, though many people who win by chance believe they can. Personally, as a contrarian, I take that view that when something goes mainstream, the value gets priced out immediately. The best thing you can do is to UNDERSTAND what you are looking at investing in rather than following advice, it takes time, but you're more likely to find it helps you make money than asking advice from random people off the Internet

john_s_2

<sigh> well my reading up on this subject has been contradicted in almost every post! Namely, trackers are safer than managed funds (perhaps safer isn't quite the word I'm looking for). This conclusion was reached by reading things like this:

"The evidence so far is that trackers are providing a good deal for their clients. When markets rise they are among the best performers. But when a bear market begins to bite, trackers slip down the fund performance league tables. However, even in this case, they still do less badly than many of the large popular funds favoured by small investors."

http://www.thisismoney.co.uk/help-and-advice/advice-banks/article.html?in_advicepage_id=105&in_article_id=394220&in_page_id=90

And I've read in loads of places that GEBs are to be avoided in preference to investing in equity funds (the loss of potential gain is not worth the capital guarantee).

Which just goes to show, I think, that I need to continue researching, and biding my time until I'm happy.

Anyone recommend any books on the subject? I prefer to sit down with a book than read articles on-screen.

Thanks to all who commented.

thrupence

john_s wrote: »

<sigh>
Which just goes to show, I think, that I need to continue researching, and biding my time until I'm happy.

Anyone recommend any books on the subject? I prefer to sit down with a book than read articles on-screen.

Thanks to all who commented.

When picking managed funds it's very important to assess the manager. Some are very good and some are useless, and everything in between.

You can assess a manager's ability quite quickly by using this tool on Best Invest.

http://ww2.bestinvest.co.uk/fundmanagers/fmpro?-db=webprices.fp5&-format=index.htm&-token=&-token.1=99&-token.2=5&-token.3=3&-view

Read up on it and see exactly what they're assessing and you'll find many other sites with similar approaches.

What I do is firstly work out what sector or asset or whatever I'm interested in and then I look for the best manager in that field. Then I get a few top ones and compare charges etc.

It's the same as anything. You're looking for the best person with the best rates to do whatever job you want doing.

ETFs are worth looking at too.

Aegis

john_s wrote: »

"The evidence so far is that trackers are providing a good deal for their clients. When markets rise they are among the best performers. But when a bear market begins to bite, trackers slip down the fund performance league tables. However, even in this case, they still do less badly than many of the large popular funds favoured by small investors."

http://www.thisismoney.co.uk/help-and-advice/advice-banks/article.html?in_advicepage_id=105&in_article_id=394220&in_page_id=90

I'd question that claim, vague as it is. There's a table going round at the moment showing the best FTSE AllShare tracker relative to the rest of the AllShare sector for managed funds, and I think it appears in the top 10% once in the 20+ years that the tables show. The rest of the time it hangs around mid-table, hardly among the top performers.

I'm always curious as to where these claims come from. Presumably it must be looking at one of the sectors where trackers generally do outperform managed funds, like the US. However, as mentioned here before, there are tax reasons which could explain that outperformance in the states but not here.

cheerfulcat

Aegis wrote: »

I'm always curious as to where these claims come from. Presumably it must be looking at one of the sectors where trackers generally do outperform managed funds, like the US. However, as mentioned here before, there are tax reasons which could explain that outperformance in the states but not here.

Hi, Aegis,

The argument for trackers is that most fund managers are constrained by a benchmark - for the average UK equity fund that benchmark is the FTSE 100 or the Allshare. So they are effectively tracker funds with added expenses... on the whole the return after charges is less than that of the trackers. Looking at the tables in the latest What Investment magazine, the total return from £100 on the FTSE 100 is £103.20 and the FTSE Allshare £112.36. The average from managed funds in the UK all companies sector is £109.32.

On a more general note, I think that it's best to work on the principle of maximising diversification and minimising charges.

dunstonh

And here are the performance stats that Aegis mentioned copied from a recent thread:

I have put the percentile in brackets. Sector average is mid table so would be 50. If a fund is (1) that makes it top. If it is (100) it makes it bottom. Each year is discrete performance (performance only for that year)I have also topped it off with the 10 year cumulative figures (if you invested on 1st Jan and held for 10 years what the return would have average in percentage terms). These are after the annual management charges.

[php]Year Sector Average L&G 100 L&G all share

1996 16.62 13.75 (73) 15.15 (60)
1997 18.29 26.99 (13) 22.01 (46)
1998 9.78 15.22 (23) 13.13 (35)
1999 26.07 17.30 (89) 23.18 (54)
2000 -4.58 -9.78 (89) -5.73 (53)
2001 -14.67 -15.41 (68) -13.17 (38)
2002 -23.55 -23.88 (58) -22.97 (42)
2003 22.66 15.32 (96) 19.99 (57)
2004 12.65 8.69 (85) 11.88 (48)
2005 21.23 17.94 (83) 21.11 (43)
2006 17.46 12.39 (89) 16.42 (53)
2007 1.62 4.83 (34) 4.45 (37)
10 year cumulative
5.55% 3.18% (94) 5.68% (46)

[/php]

So, we can see from those figures supplied by Financial Express that neither the FTSE100 or FTSE index trackers from L&G have managed to enter the top 10% of funds at any point since 1996. The L&G 100 did come close in 1997 by hitting 13% but over 10 years but spent most of the time at the bottom end. It had a cumulative return that put it ranked at 94%. You would have had a harder job picking a managed fund that fell into the bottom 6%. Also, the all share can be seen to be more consistent at the mid table range as you would expect.

it suggests that trackers don't do as well as active

That isnt the right conclusion to make. A managed fund will have an objective and that objective will not usually be the same as a tracker fund. Whilst the FTSE100 has been an awful place to invest for 15 years now, the FTSE250 had a very good run for a lot of that period. So, trackers covering the 100 did awful. trackers covering the 250 did very well (until recently when they bombed as the mid caps took the biggest hit). If the area the index tracks does well, then the tracker will do well. A managed fund will pick different areas (assuming active managed and not passive managed or bank/insurance company funds generally).

<sigh> well my reading up on this subject has been contradicted in almost every post! Namely, trackers are safer than managed funds (perhaps safer isn't quite the word I'm looking for). This conclusion was reached by reading things like this:

Trackers are not safer. I dont know where that myth comes from but we often see it. They are actually a tad riskier than most funds in their sector because of the lack of downside protection they offer. This can do them well in good times but hinder them in bad (generally). A FTSE all share tracker is medium high risk and you have to accept 50% potential losses on a 12 month period as possible. It certainly isnt lower risk or cautious and going 100% into one is not for the faint hearted.

A lot of the tracker myths come from America. In the US managed funds suffer greater taxation than trackers. The charges tend to be higher than in the UK as well. So, managed funds have a double whammy against them over there. In the UK, the taxation is no different and the charges difference has come right down and the difference in performance can be less than one hours trading on the stockmarket. At time of posting, the FTSE100 is up 0.9% (after 1 hour) - thats more or less the annual difference between managed funds and trackers in the UK. Are you really worried about something that can be wiped out potentially in one hour?

There is also the commercial side to certain sites that sell trackers. MF for example sell trackers. Guess what they promote? Their claims are not in context. 9 out of 10 trackers will beat managed funds with the same objective is what it should say. Problem is very few funds have the same objective. It only tends to be the passive managed funds, bank and insurance company funds. Avoid those and you improve your odds significantly.

And I've read in loads of places that GEBs are to be avoided in preference to investing in equity funds (the loss of potential gain is not worth the capital guarantee).

Every now and then a good GEB comes along. Usually a combination of timing and getting the right provider. Often these come from the institutional providers that also make available to retail (but not on a large scale) rather than the retail providers. However, most of the time GEBs are a waste of money. Building your own GEB is often a better approach. This is mainly down to the cost of the guarantee. Whilst GEBs tend to have no explict cost (a bit like a savings account), there are charges on them and the are built into the terms and hidden (known as implicit charges).