Tracker funds: Investment for all ages
What is more, investors in these funds are, on average, more than five years younger than active fund investors, according to figures from Interactive Investor. So what is the attraction of passive investment and does it make sense for this age bias to exist?
The fund management industry is founded upon the belief that markets are inefficient; not all information is widely or freely available and, even if it is, this information is not efficiently priced into the market. Active fund investors believe expert fund managers, studying specific countries and sectors and analysing individual companies, can create a fund that will perform better for investors than holding a passive basket of individual stocks.
But while there is no doubt opportunities and anomalies in the market have existed in the past, the key question is whether those opportunities still exist now?
The increase in technology, global awareness and computer trading neutralised many of the pricing anomalies that previously existed and from this, the passive fund market emerged. Passive fund advocates consider markets are broadly efficient and that while active managers might be able to find good exceptions, they are just as likely to find companies that underperform.
The passive fund market thinks an investor who wants exposure to a particular country or sector should just buy into a fund which mimics the relevant index – and with a computer rather than an individual making any underlying changes to a passive fund portfolio, they can do it for a fraction of the annual management fee that is charged by their active fund equivalents.
The passive versus active debate has run and run since passive funds arrived 20 years ago, and figures do tend to show that on average, over most longer timeframes, passive funds perform better.There will always be exceptions to this and, of course, it is only possible to be able to invest in a passive fund if you have a particular benchmark you're trying to match, such as the FTSE 100. But for investors who simply want to take the first step on the investing ladder, passive funds offer significant appeal.
Age no barrier
So should younger investors or older investors consider tracker funds as a good fit for their portfolio?
Instinctively, one might expect young investors would be taking a more active role in their investments and older investors would move into more of these tracker funds, but we've seen exactly the opposite. While active funds are still by far and away the preferred option, it appears as if an increasing number of investors who are starting out are starting and staying with passive funds.
With less time, less money, and possibly less interest in investing, while also appreciating that stepping on to the investing ladder is necessary, low-cost tracker funds are a great choice for new investors.You don't have to worry as much whether you've made the right choice, because you're automatically settling for benchmark returns. Younger investors are also likely to be investing for growth, rather than generating income from their investments, so overall, it is easy to see why passive funds appeal.
Older investors who are moving into income generation and supplementing retirement will be choosing high-yielding options, in particular for their Isa investments, where the non-declarable and no further tax to pay angle from income makes it a highly attractive choice. With more time and probably more money, it is easier to take an active role.
Passive fund investing might seem like a cop-out to some, but if you have a long time horizon and want an investment that requires less of your time, then it's a great place to start.
Rebecca O'Keeffe is the head of investment at Interactive Investor. Email her at firstname.lastname@example.org
Also known as index funds, tracker funds replicate the performance of a stockmarket index (such as the FTSE All Share Index) so they go up when the index goes up and down when it goes down. They can never return more than the index they track, but nor will they lose more than the index. Also, with no fund manager or expansive research and analysis to pay, tracker funds benefit from having lower charges than actively managed funds, with no initial charge and an annual charge of 0.5%.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
A standard by which something is measured, usually the performance of investment funds against a specified index, such as the FTSE All-Share. Active fund managers look to outperform their benchmark index. Cautious fund managers aim to hold roughly the same proportion of each constituent as the benchmark, while a manager who deviates away from investing in the benchmark index’s constituents has a better chance of outperforming (or underperforming) the index.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.