Investing in an index of recognised companies makes decision-making far easier and will certainly be the cheapest way to build up a portfolio in the stock market.
It means that a raft of shares can be purchased which is likely to be far more than almost any individual can amass on a company by company basis. In turn, this means the volatility is reduced immensely.
The world’s leading individual investor, Warren Buffett, urges passive over active. He has left instructions that on his death, all personal assets should be placed in trackers for his beneficiaries.
Trackers aim to replicate the performance of a particular asset class or index in one of three ways:
Full replication of all the underlying constituents of an index
Stratified sampling where a representative sample is held
Optimisation where a computer model selects the sample of securities.
For investors, there is a competitive advantage in saving this way. Tracker funds are usually much cheaper than actively managed collectives. The typical annual fee is around 0.1 per cent which compares with 0.75 per cent or even more for an actively managed fund.
However, “whilst a passive approach should be cheaper, there are some caveats”, warns Kelly Kirby, chartered financial planner at adviser Chase de Vere in Leeds.
Kirby says some trackers are more expensive, such as the Virgin FTSE All-Share fund which recently reduced its annual charge from one per cent to 0.6 per cent and yet has over £2.7bn invested in it.
The likely annual cost quoted for a tracker is not the full sum as there will be a further fee for the ‘platform’, which is the wrapper. This allows the investment to be held in a tax-efficient way through an ISA or SIPP. Expect a typical further charge between 0.25-0.45 per cent.