I often wonder if some investors look down on index funds. Maybe – as an easy option – they feel they’re a bit of a cop out. Or maybe they feel these low cost, passively managed investment options aren’t somehow as good as their actively managed counterparts. Well, sshh. Don’t tell anyone. But I hold a couple of index funds in my portfolio. And I’m not looking down my nose at them at all.
What is an index fund?
For anyone wanting a bit of a refresher, an index fund (also known as a tracker or passive fund) is a fund that aims to track the performance of an index – such as the FTSE 100, S&P 500 or MSCI World Index. And, unlike an actively managed fund that’s tying to outperform the market, a tracker is happy to mirror what the market’s doing.
Why I like index funds ?
1. They’re low cost
Annual charges can sit around the 0.1% mark for a tracker fund. This kind of charge is quite typical of a passively managed fund, with some charging a little more and some even charging under 0.1%. An actively managed fund can charge much more, perhaps even ten times as much.
2. They are an easy option
And that’s okay. Easy doesn’t mean below par. It just means that once you’ve invested you can step back and let the markets do the work. And because tracker funds follow a specific index, they’re less likely (but not always) to be affected by market volatility.
3. They’re typically well-diversified
I say typically, because it’s always best to look under a fund’s ‘bonnet’ to see exactly what it holds – as it may be diversified in terms of sectors, but it might not be diversified geographically for example. If you go to the ‘portfolio’ tab and scroll down. It gives you tons of information, which shows everything from where in the world it’s invested, to the asset allocation (what mix of investments it holds – such as equities, bonds or cash) and its top 10 holdings. To give you an idea of how diversified they can be, the best-selling fund for ISA investors in 2023 was the Fidelity World Index World Fund, which has a total number of 1,482 equity holdings at the time of writing.
4. They can offer reasonable returns
You might wonder why I’ve left this until lower in the list. Isn’t performance everything? When the going’s good of course it’s a positive thing. But not every index fund does well. However, history shows that the stock market increases in value over time. It means, in the long run, index funds have the potential to provide investors with reasonable returns for a low cost, making them good value for money.
5. I’m not the only tracker fund fan – the secret’s out
It seems that tracker funds are popular with our customers too. In fact, two of the tracker funds that I hold are in the top 10 most popular ISA funds in 2023.
And 14 tracker funds are listed on the Select 50 – a list of our favourite funds, picked by experts. You can read about Select 50 tracker funds here. Fidelity Investment Director, Tom Stevenson, has also chosen the Legal & General Global Equity Index Fund as one of his four fund ideas for 2024.
What are the downsides to index funds?
I’ve spent a lot of time talking about why I like an index fund. But there’s no such thing as a sure thing in investing. Markets rise and fall. And risk goes hand in hand with reward. Here are a few things to consider when you’re thinking about investing in a tracker fund.
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No guarantees – While an index fund aims to track the performance of an index, there’s no guarantee that the investment objective of any index-tracking sub-fund will be achieved – as the performance of a sub-fund may not match the index’s performance due to other factors (such as the investment strategy used, fees and expenses and taxes).
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Think about your goals – index funds, by definition, track an index. They’re not trying to outperform the markets. And if that’s what you’re looking for, an index fund might not be for you. On the flip side, if the markets are doing well, you might be happy with your returns. Which leads me nicely onto…
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Be honest about how comfortable you are with risk – Different index funds have different levels of risk, so make sure you check its risk rating. You can find this on the ‘risk and rating’ tab in the fund information online. And you’ll see it will show you where it sits on the risk and reward spectrum.
