Best Tracker Funds – Forget Single Stocks

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best tracker funds

The Best Tracker Funds

Let’s get right to the point. Buying the best tracker funds is the answer to all your investing dilemmas. Forget what your grandad told you about accumulating a single company shares portfolio filled with Shell, Marks & Spencer, Rolls Royce and Lloyds Bank. You can’t blame grandad because that is what his trusted financial advisor told him to do; the same advisor who was paid handsomely from trading commissions and management fees.

I understand financial advisors have to make a living, but no one says you have to fall into the same fee paying trap your grandad fell into. There is a better-investing strategy that greatly reduces risks and fees, and greatly increases returns.

Choose the best tracker funds instead.

“There seems to be some perverse human characteristic that likes to make easy things difficult.”

– Warren Buffett

Warren Buffet’s words are extremely insightful. Humans love to complicate things, especially when it comes to investing.

So why choose the best tracker funds? Three reasons. They are low in fees, they outperform virtually all managed funds over a long period of time and they are tax efficient.

I once spoke with a financial advisor who argued I was wrong about tracker funds and that you get what you pay for with actively managed funds. I respectfully told him I disagreed, told him the facts to which he responded, “Well people don’t want tracker funds, they are too boring”.

Any financial advisor who advises you to buy managed funds might be trying to separate you from your money by way of management and trading fees. There are countless professional investment fund managers who have lost money year after year and most managed investment funds have underperformed the index markets since inception. But ingenious branding and expensive ads campaigns continue to lure new customers into thinking these managed funds somehow perform better. Historical stock charts show otherwise.

Did you know there are over 29,000 unit trust funds available to UK investors with more being added daily? With a tiny percentage of these funds outperforming the indexes, how could anyone possibly pick the correct funds, let along understand them? Another issue is one fund might perform gloriously one year while the following year, it could fall flat on its face due to the fund manager picking the wrong stocks.

Do you know some of the mega-funds hold the same investments but charge different fees? For decades, stock funds were shrouded in hidden fee mystery until the Government finally said enough and forced fund companies to be fee transparent.

The financial services world is complicated for a reason because if it weren’t, very few people would need financial advisors.

Previously, I wrote an article about why you should avoid checking share prices and avoid buying single company stocks because it’s too risky.

So if not single stocks, then what?

The answer is to buy the best tracker funds, also known as index tracker funds. They are simple, outperform managed stock funds year after year and most importantly, they have low fees and are tax efficient.

When you start looking for the best tracker funds, the financial services will be out to dissuade and confuse you with a myriad of options designed to have you running back to your trusty financial advisor to buy managed funds. Very few people need a financial advisor to invest.

So how do you know which are the best tracker funds to buy?

Firstly look for low cost and simplicity. My best tracker funds list is very short as my entire share portfolio exists of just two tracker funds:

Best Tracker Funds #1
1. Vanguards US Equity Tracker Fund

2009 Launch Price: £100
July 2017 Price: £395.69
Risk Level: 7/10
Annual Fee: 0.10%
Purchase Fee: 0%
Exit Fee: 0%
Total Assets: £2.6 bn
Total Stocks In Funds: 3400+
Where To Buy: Vanguard UK or most trading platforms
Min Investment: £500 directly from Vanguard, 1 share from other platforms

This U.S. S&P 500 fund makes my short list of the best tracker funds because it holds over 3400 stocks meaning you own nearly every stock in the S&P. All companies are including, everything from Apple to Smuckers. The fund purchase stocks in a weighted format. For example, the largest weighted stock is Apple which makes up 2.9% of the whole index, so the tracker fund owns 2.9% of its holdings in Apple stock equalling £124m. This continues all the way down to the smallest company which is currently Gevo, representing 0.00001% of the S&P or £528 worth.*

* As of July 2017

The beauty of this type of fund is that you benefit from company growth and you receive dividend yield. As of August 2017, the annual dividend yield was 1.30% and you can receive this dividend as a cash payment (Income Fund) or you can reinvest dividends (Accumulation Fund).

Vanguard’s US Equity tracker fund is the ultimate in diversification because the performance of one company won’t have a huge effect on the total market, therefore offering greater risk protection. Yes, the fund will perform poorly in poor market conditions, but so will most managed equity funds. Do you want to gamble on being able to choose one of the few managed that can outperform the market? Instead of trying to pick winners from 29,000 unit trusts, pick one tracker fund that owns the entire stock market and performs year after year.

The S&P 500 has averaged returns in the region of 12% annually since inception, (including dividends and compounding interest). If you simply bought index funds and held for 40 years, you’d be very happy. This investment product tops my very short best tracker funds list for a reason.

The Vanguard fund is valued in U.S. so you do have some currency risk, but the pound has historically favoured well against the dollar (yes, I expect the £ to recover somewhat post Brexit).

So why not buy a FTSE tracker?

The FTSE 100 is too small and not diverse enough for my liking. At one time, BP, Shell and HSBC comprised almost 25% of the FTSE 100. That meant if anything happened to one of these three companies, the FTSE as a whole suffered. Personally, I prefer to be as diversified as possible.

The FTSE 100 has also historically underperformed the S&P500 by large percentages:

Best Tracker Funds

With stock market returns, all we can look at is history and while history is no indicator of the future, you can see how badly the FTSE has lagged behind the S&P500. That being said, some people are only comfortable buying UK investment products, so always do what is right for you.

And why not a global index tracker?

Same reason as its historical returns are much worse than the S&P500:

Best Tracker Funds

Best Tracker Funds #2
2. Vanguard Global Bond Index Fund

June 2009 Launch Price: £100
July 2017 Price: £146.52
Risk Level: 3/10
Annual Fee: 0.15%
Purchase Fee: 0.20%
Exit Fee: 0%
Total Assets: £2 bn
Total Bonds In Funds: 8000+
Where To Buy: Vanguard UK or most trading platforms
Min Investment: £500 directly from Vanguard, 1 share from other platforms

This global bond is #2 on my best tracker funds list because its fees are low and it holds a mix of 8000+ world government and corporate bonds. It’s the ultimate in bond diversification which pays a 1.62% annual yield (as of July 2017).

Bond funds won’t make you rich and are more boring than your grandma’s knitting lessons, but they do hedge against stock market corrections which is the primary reason to own them. For example, the U.S. equivalent Vanguard Total Bond Fund gained 3.45% during the 2008 market crash while most managed stock funds lost 45%. When markets are falling, you can exchange some of your bond fund holdings into stock funds when the worst is over. Think of bond funds like insurance, you hope you won’t need them but you’ll be glad you have them when the markets are falling.

So why not a UK bond fund?

A UK bond fund is higher risk than a global fund as it is far less diverse. For example, Vanguard’s UK Government Bond Fund only holds 58 bonds versus the 8,000+ bonds in the Global Fund.

Here are the return comparisons both funds launched in 2009:

Best Tracker Funds

While the UK bond fund has outperformed the global fund since 2009, I would expect the higher risk of the UK fund to level out long term returns over a longer sample size. Also, remember that interest rates have been highly volatile since the 2009 property crash resulting in unusual bond fund returns that have tapered off.

Why Vanguard?

Customers have entrusted over $4 trillion in Vanguard’s hands making them one of the largest fund companies in the world. Aside from Vanguard’s stability and reputation, company founder Jack Bogle was the man responsible for the launching the very first index tracker fund back in the 1970’s.

Vanguard has a long history of low fee investing. Other companies offer low fees as an introductory rate, then quietly hike their fees. If you do invest in a company other than Vanguard, pick the companies with the lowest fees as most offer identical products.

Best way to buy trackers

Since everyone has different circumstances and needs, use the Compare Fund Platforms tool to see which brokerage is the most cost effective.

You can invest directly with Vanguard but each fund has a £500 minimum initial purchase If you want to purchase less than £500 in each fund to start, the most economical way is to set up an account with a discount brokerage such as Iweb (Halifax). It costs £25 to open an account but each trade is only £5. After you reach the £500 fund minimums it’s highly cost effective to transfer to Vanguard if your current trading platform doesn’t charge you transfer fees.

Buying through a discount broker will save you lots of money over the long run because you can avoid annual platform fees. For example, Charles Stanley charges an annual 0.25% platform fee which really adds up over the years even though it doesn’t sound like much. If you don’t trade often and your account balance is under £80,000, you’re better off investing directly through Vanguard since their annual account fee is only 0.15% (you can read more about this here). Keeping fees low is crucial to successful long term investing.

You can also buy trackers in the form of ETF’s or Exchange Traded Funds. I personally don’t buy these because ETF’s can be traded like stocks and I don’t like the temptation of easy liquidation.

So that’s how I invest in the stock market; two tracker funds and done.

How much to invest?

So how do you decide how much to put into each type of the best index trackers? Stock tracker funds are much riskier than certain bond tracker funds but the payoff is greater. For example, here is how Vanguard’s stock tracker and bond trackers performed during the financial crisis between May 2008 and May 2009 (I used the US equivalent funds as the Vanguard UK fund equivalents didn’t exist at the time):

As you can see the stock index fund suffered far worse losses than the bond fund. A stock tracker fund will fall as much as the entire market falls whereas a bond fund tends to be less volatile. It is suggested you take your age and use that as the percentage of bond funds you should own. Example: A 35 year-old would own 65% stock index funds and 35% bond index funds. You can adjust that based on your risk tolerance. I’m in my 40’s and own about 35% in bond funds. As you get older you can adjust this as needed (we call this rebalancing). A 20-30 year-old can afford to take more risk since they have time to rebound if disaster strikes, so their portfolio might be 90% stocks and 10% bonds.

When considering bond trackers, I recommend avoiding corporate bonds funds as these bonds are debt held against private companies and are much riskier.

This article highlights my personal preferences. Take time to research the trackers as there are many offered by many different companies. Make sure you pay attention to what the trackers hold in their portfolios and the fees. As always, you should never invest in anything you don’t understand.

Conclusion

Consider kissing those risky single stock portfolios goodbye and buying and holding the best tracker funds. This strategy is by far the least risky and most cost effective way to achieve retirement wealth. Even the greatest investor in the world, Warren Buffet, agrees:

“The trick is not to pick the right company, the trick is to essentially buy all the big companies through the S&P 500 and to do it consistently and to do it in a very, very low cost waY”

Warren Buffet
CNBC Interview May 2017

 


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Disclaimer: This article is for information purposes only and should not be regarded as investment advice. Opinions expressed are my opinions based on my own personal experiences, investing my own money.