With the tracker funds in the last two decades, it has become possible for the likes of you or me to gain exposure to the markets without facing the hefty charges involved in buying actively managed funds.
In the mid-1990s, having previously been the preserve of big financial institutions, tracker funds moved into the mainstream.
More recently these passive mutual funds have been overshadowed by the rise of exchange-traded funds or ETFs, but if you are used to investing through funds, the humble trackers can be a simple, low-cost way of investing your capital.
As their name suggests, tracker funds track a market index – whether it’s the S&P 500, the FTSE 100, a global index or a Far East index. They are a straightforward way to invest because you simply receive the return of the index being tracked, minus a fee. When the index goes up, the same is true for your investment. When it drops, your investment worth is going to decrease as well.
It’s possible to build a fully diversified portfolio with trackers alone – and you don’t need to invest in a large number of trackers to achieve this diversification. A global trackers provides exposure to thousands of shares across the world. And they do not just track equities they can also provide exposure to government and corporate bonds too.
They are cheap; some have annual fees as low as 0.1% compared with the average for actively-managed funds of 0.75%. In some cases, the trackers can be ten times cheaper than an active fund in the same sector.
A 0.75% charge might not seem huge, but costs soon add up and eat into your overall investment returns. Based on Vanguard findings, over 75% of sufficient funds underperform their criteria during 10 to 15 year time periods due to the fact that service fees compound through the years. The worst type of market is United States equities, where virtually all sufficient funds underperform their particular standard.
Another advantage of trackers is their transparency – you always know exactly what you’re investing in. With an actively-managed fund, you have no way of knowing all the stocks the fund manager has your money in. Most funds only publish a list of their top ten holdings.
The biggest drawback of trackers is that there is never an opportunity to get market-beating returns. They can only ever, by definition, track the market and although fees are modest, they still exist. This means they will always return slightly less than the market they are tracking.
On the other hand, not many capable professionals persistently pulled ahead of their benchmarks and the long-term market build up.
The tracker versus active fund debate often boils down to which market you want to invest in. Trackers tend to work best in very liquid markets – where the market is traded very heavily, a lot of information is quickly available about its constituents and indices are efficient, cheap and easy to trade in.
This means it is less likely the market will have got the share price of a stock wrong. In less liquid markets where the stories of individual companies are less well understood, fund managers can add more value.
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