The question we’re most often asked in our guise as passive investing nerds is: “Should I buy index funds or Exchange Traded Funds (ETFs) as my tracker vehicle of choice?”
A quick recap:
- An index fund is a unit trust (or OEIC) whose portfolio is designed to track the return from a particular market index.
- An ETF is a security that is again designed to track the return from a particular index. ETFs trade on stock markets like any other share, and their price moves up and down during the trading day.
So are there different situations – or types of investor – for whom an index fund trumps an ETF, or vice versa?
This isn’t new territory for Monevator. We’ve looked before at the differences between ETFs and index funds. We’ve even done a huge multi-part guide to buying the best index tracker on a fund-by-fund basis.
However we’re now going to break it down into a bite-sized battle of the trackers.
Over a half-a-dozen small posts, we’ll look at each of the aspects you need to consider in your quest to find the best funds for you.
We’ll start by explaining why you should buy index funds if simplicity is your most important consideration!
Index funds are simpler than ETFs
If simplicity is paramount to your investing life then index funds are the way to go.
Like the mortice lock or the four-legged chair, index funds are straightforward products that do a good job and aren’t subject to the constant product innovation and morphing that can make ETFs something of a minefield .
Index funds have been available since 1975 with nary a whiff of financial scandal that entire time.
With index funds you can skip complications that affect ETFs like:
- Synthetic index replication that exposes you to counterparty risk.
- NAV premiums and discounts that affect cost calculations.
- Wide bid-offer spreads that make illiquid ETFs more costly.
- Dealing fees (unless you choose Vanguard funds).
- Using limit orders to control your buy/sell price.
You don’t need to understand any of that with index funds, and you can buy index funds cheaply through a fund supermarket or online broker.
Part two: Which vehicle is best when it comes to cheaper costs?
Take it steady,
The Accumulator
Thanks for the article. I’m looking forward to the other 5 now.
It would be great if as part of this mini-series, you could provide an opinion as to point when it makes sense to move out of the low cost index tracker, and into the Vanguard funds (for both ISAs and SIPPs). Someone in the previous comments mentioned an 18K figure, though I couldn’t seem to work out how it was calculated.
I’m really interested in the new vanguard lifestyle funds. So much so I’m considering splitting my future passive investing 50% my own index tracking portfolio, 50% Vanguard lifestyle (only once it becomes cost effective to do so).
This will hopefully give me some diversification (in case I’ve done something terribly wrong with my own allocation), whilst allowing me to compare my efforts against Vanguard’s (to spice up the “catatonic” element some what).
I’d love to know where the £18k came from as I’m currently looking at going passive.
Hargreaves Lansdown SIPP and HSBC trackers seems like an OK option, with “HSBC Gilt Index”, “L&G Global EM Index” and “Royal London Index Linked Gilt” running alongside. The TERs of the latter three are 0.27%, 0.99% and 0.43%, so my overall weighted TER will be 0.372%, which compares to Vanguard lifestyle but will be £160 per £100k more expensive per annum than separate Vanguard funds via sippdeal. (A little less if I don’t choose inflation linked gilts and go for less EM weighting.)
The plus with HL is no dealing fees and no dilution fees, which means I can easily move later on if a much better option surfaces. The funds I’m considering with HL are also those that avoid the extra 0.5% (capped at £200 pa) which really helps.
Fidelity is another option, and they have both HSBC and L&G gilts (fixed and linked) all at low TER, but I can’t find out much about other charges.
Thoughts?
@ Jonny – It would depend on which funds and how often you trade in the year. Once the differential in TER outweighs the Vanguard trading fees (and any difference in annual admin charges) then you have your magic number. Check out the fund cost comparison calculator here:
http://candidmoney.com/intro/calculators.aspx
@ Gadgetmind – watch out for H&L charging an extra 0.5% on some index funds.
I just came across all this great info published by ‘The Accumulator ‘, and many thanks to him.
The reason i stumbled here is that i am in the process of hurriedly seeking a new home for my index tracker investments, held both in ISA and SIPP format with Hargreaves Lansdown. But today I had the pleasure of receiving from HL details of their new fees – effective Dec 31st 2011.
For each fund (platform is the term they use) that I hold with them (5 x HSBC tackers [UK,USA,Europe,Japan,Pacific and 1 x L&G tracker [emerging]) they want to charge £2 per fund per month.
To anyone else here with HL and invested in index tracker funds that to date paid no additional fees, maybe now is the time to look elsewhere?
Vanguard looks interesting. I plan to look more into what’s available on that ‘platform’. Any other suggestions warmly welcomed?
I hope my post may have alerted others to what HL have in their pipeline.
@Steve — Welcome to Monevator and thanks for the heads up! We’ve been alerted to this by a few of you kind readers over the past 24 hours, and we’ll have a post up on it very early next week.
Thanks for the response ‘The Investor’. I look forward to reading what is posted next week.
Note that HL have said in an email, “Previously, we had covered the costs of providing a number of tracker funds, but as demand for these funds has increased so have our costs. We are therefore introducing a platform fee to cover these costs and allow us to increase the range of funds we offer. We expect to be able to offer Vanguard funds shortly, for example. Like all other funds they will be available with a minimum of £1,000 (£500 is the Junior ISA) and we will make no charges to buy or sell.”
I have asked them if they will cover the Vanguard LifeStrategy funds.
Also note that HL give more detail in issue 89 of their Investment Times, which arrived with me today.
I was about to put £200k into a HL SIPP, and move some *significant* ISAs their way to join our existing ones, but I might now be fleeing in the direction of Fidelity (still free for HSBC trackers), Interactive Investor, or BestInvest.
@Gadgetmind — Great info, thanks!
For what it’s worth, if I was looking to home significant six-figure sums in passive funds I wouldn’t be overly influenced by finding the very cheapest place to hold my money. It’d certainly be a factor, but I’d also look at platform access, customer service, range, and so on, and I’d personally split my net worth across at least two unconnected top tier platforms (if not more).
Let’s say you split £200,000 across three tracker funds with HL, so £6 a month / £72 a year. That is only going to add 0.036% to your annual costs. Some other factors may be worth at least considering at this level.
The fee will however really hit those with four or low five-figure portfolios, for whom it’s a real smack in the teeth.
Please do let us know if you hear back from them about the LifeStrategy funds!
Will do regards LifeStrategy, but I have issues regards three trackers with HL. A good balance of sectors had me looking at 6 HSBC equity trackers, an L&G EM tracker, gilts in HSBC and Royal London, and a Blackrock property fund.
I like HL. I really do. Great customer service, etc., so let’s hope they can weather this.
BTW, please let me know if you need a scan of HL’s bumf regards platform fees.
@Gadgetmind – Understood re: three trackers, you’re talking to a man who favours redundant extreme diversification, just in case, once you’ve got proper wealth to preserve. But I know many passive investors keep it simpler (Mike at Oblivious Investor, for instance, was invested across just two funds last I heard).
Even with six funds you’re not going to be paying an ordinate annual fee compared to the funds invested. And to be fair to HL, it’s not as if having significant money at risk for clients is costless…
Thanks for the offer of a scan. The Accumulator has already got up-to-speed and we have the post here ready to go — was just toying with putting it up on a Sunday, indeed, which is unprecedented around these parts, but given the good work of yourself and others in alerting us to the new charge, seems only appropriate!
I don’t object to paying a platform fee (will soon have no choice) but I hate the way that HL’s HSBC fees penalise those who seek diversity. I was looking at over £200 a year for the combo I was after, and the same again in my ISA, and my wife’s ISA. No thanks! Other platforms have a flat rate, or a cap.
Oh, and while HL have a cap of £200 on the 0.5% for holding ITs, ETFs and shares in a SIPP, all those £2pcm fees for the trackers don’t contribute towards this cap, so you could run up huge fees very easily.
Regards diversification, I also hold a lot of RIT, Ruffer and Personal Assets. I have *loved* the way that PNL has picked up nearly 10% this year, and know deep down that I should be be giving it a haircut and putting more into equities, but I have fresh money coming in to spare me this heartache.
@steve
i’m in the same boat
would be very interested to know what you come up with as alternative. I will be doing my own research as well and will prob report back on Monevator with my findings.
Two things I really want to get a handle on:
1. How to exit HL at the lowest cost, e.g. should I sell each fund and then exit holding only cash, or should I sell and then buy just one fund and then exit – if they’re charging per fund this could save me a few quid
2. Changing platforms is a pain and costs – whats the betting I change to a new platform then the same thing happens a few months down the line? I’d like to choose a platform that is not running passive portfolios at a loss ideally as I think they will be least likely to change their charges. To this end possibly a platform with a fixed AMC is more sensible in the long run?
any way, I’m off to do some research…
BestInvest is looking best to me, but I’m mainly looking at a SIPP. It will cost £50+vat in an ISA or £100+vat in a SIPP, but they have both Vanguard and HSBC trackers, and a decent looking Blackrock property tracker.
@gadgetmind
bestinvest does look good for the SIPP, they may even cover exit fees.
Alliance Trust could be another option for your ISA, £25+VAT AMC, has vanguard, one free trade included annually – not sure about your Blackrock REIT.
were you on MSE talking about this too?
@ Ben
I’ll take a closer look at Alliance Trust, but they seem to have a higher annual fee and dealing costs even for these funds.
I’ve been talking about this here, MSE, Citywire, and a few other places!
@gadgetmind
having spent today trying to understand the charges for a bunch of platforms I agree with you that its a bloody nightmare. The websites range from OK (Alliance Trust, TD Waterhouse) to absolutely dreadful (Fidelity). They all look superficially professional, its when you start to try and find the details on funds available, charges etc. that you realise how bad they are.
I’ve tried to distil some of my findings in a spreadsheet, linked from the other thread on here…
The TD Waterhouse site was pretty much unusable with my version of Firefox and I pretty much gave up!
Fidelity has a decent fund filtering system, but I found it hard to find all of the assets I’d need for diversity (no low TER property, no ETFs, etc.)
BestInvest was OK but has two totally different search systems both of which kick out different lists of funds. GOK which you can actually buy and how!
@Ben
I am invested in 6 different funds; all spread across my own ISA & SIPP as well as my wife’s own ISA & SIPP.
Currently having multiple funds invested in each SIPP, I may consider consolidating into one single fund and reluctantly accepting the new charges.
An example of what could be possible:
Current holdings in SIPP before consolidation:
Fund A £10,000 (£2 per month fee)
Fund B £4,000(£2 per month fee)
Fund C £2,000 (£2 per month fee)
Fund D £2,000 (£2 per month fee)
Fund E £1,000 (£2 per month fee)
Fund F £1,000 (£1 per month fee)
Total held = £20,000
Fees = £11 total (£22 if same position for both husband and wife)
Current holdings in ISA before consolidation:
Fund A £10,000 (£2 per month fee)
Fund B £4,000(£2 per month fee)
Fund C £2,000 (£2 per month fee)
Fund D £2,000 (£2 per month fee)
Fund E £1,000 (£2 per month fee)
Fund F £1,000 (£1 per month fee)
Total held = £20,000
Fees = £11 total (£22 if same position for both husband and wife)
Current holdings in SIPP after consolidation:
Fund A £20,000 (£2 per month fee)
Total held = £20,000
Fees = £2 total (£4 if same position for both husband and wife)
Current holdings in ISA after consolidation and transfer to different provider:
Fund B £8,000(£0 per month fee when transferred)
Fund C £4,000 (£0 per month fee when transferred)
Fund D £4,000 (£0 per month fee when transferred)
Fund E £2,000 (£0 per month fee when transferred)
Fund F £2,000 (£0 per month fee when transferred)
Total held = £20,000
Fees = £0 total because of transfer to another provider
However, one problem I see doing this is that rebalancing is awkward. Should you need to sell some (say £1,000) of ‘fund A’ to maintain the correct percentage level within the whole portfolio, you would not want to invest that £1,000 into another fund which would then attract a £2 fee. Also, leaving it as cash would receive little interest.
Holding the same fund both in the SIPP & ISA, where rebalancing is done within the ISA could get around this problem.
All in all, an unwanted juggling act that is a pain in the arse.
Selling and buying back the same funds would also not occur at the same time as far as I’m aware, even when instructions are placed at the same time; thus risk of buying back at a higher price. A disadvantage of holding funds vs ETFs?
These are just been my initial thoughts. I still need to do a lot more investigation on what other providers have to offer. Like you, I am wary that switching ISAs to another provider will simply be a delay in paying these unwanted fees.
@steve – If HL will do the Vantage LifeStrategy funds, then holding these plus 2-3 others to tweak you capitalisation and territory balance could work well.
I understand why HL have done this, but a charge per fund, with no cap, and no “netting off” between SIPPs/ISA/unwrapped and spouses makes them too expensive.
@gadget
I spoke with HL and they are in negotiations with Vanguard to offer their products but nothing definite
Also, they did mention that they may ‘refine’ the platform fee charging structure base on customer response
I will probably consolidate a few funds to reduce charges and sit tight to see if they bring Vanguard on board. If they do, it could once again become a very competitively priced platform.
If not, the exit fees aren’t too bad – you could perhaps turn a profit at the moment by cashing in and rebuying an ISA elsewhere (but I would never advocate such a speculative practice 😉
@ben – thanks for the info. I may sit tight with my current ISAs with HL, but I’ll be starting my new SIPP elsewhere, probably with BestInvest.
Yes, Hargreaves Lansdown *do* need to refine those fees, and quickly!
@gadget
its worth bearing in mind that alliance trust (claim to) reimburse 100% of any rebates they see from your funds.
A rough calculation based on the fact we know HSBC pays 0.1% commission to fidelity for flogging its trackers means you would be up with AT for ISAs over 30k and SIPPs over 150k in comparison to a platform that levied no charge but kept the rebates. This is based on ATs £30 and £150 charge for their ISA and SIPP respectively.
@Gadgetmind – yes, charging each fund on each platform for each spouse is just way too much. They kindly correspond with myself and wife as a unit (their mailings are addressed to both of us), but they have no issue with treating as individuals when it comes to generating fees it would appear.
The chance of a Vanguard life strategy fund is some good news, but would have to be stuck with their own levels of diversifying. Tweaking it by holding some other index funds would not be feasible with HL I believe because of their new costs. But if I can live with the underlying fund split in Vanguard life strategy, then this may be an option.
I also have my ‘protected rights’ SIPP with HL. I will not be surprised to see that incur its own separate fee
If they knew this new fee structure was a strategic plan then maybe they should have been pointing this out as a risk in investing with them. Stocks can go up as well as down, and a potential future fee structure for low cost core holdings (trackers) may result in a manufactured and non-transparent TER that makes them extremely expensive and unviable for those encouraged to start an investing career; and expensive enough too for those with already a modest sum invested.
Maybe endowment policies or similar will be the next offering.
Fidelity Platform (may be of interest to Ben?)
———————
A little research as led me to Fidelity. They don’t appear to annually charge for their SIPP or ISA (same as HL today), and a quick look through their available funds led to HSBC and L&G appearing to be available.
Link below:
https://www.fidelity.co.uk/investor/products-services/sipps/fpp-charges.page
Elsewhere on Monevator, I noticed ‘The Accumulator’ mentioning that he was invested with Fidelity; in their own index tracker (0.3% TER) if I remember correctly? Maybe he could shed some more light on the Fidelity platform?
I looked at Fidelity you can’t hold ETFs/shares in their SIPP, the cheapest EM tracker is the L&G one at 0.99% TER and I could see no cheap property trackers such as Blackrock.
BestInvest have the Vanguard trackers and the Blackrock property one, only want £100+vat pa, and answered the ‘phone on the first ring!
and if you don’t want to hold Vanguard, BestInvest won’t charge you the £100+VAT custody fee
e.g. If you just go for a HSBC/L&G like the Accumulator’s simple portfolio then the BestInvest SIPP is free.
Thanks guys.
I had previously been to the BestInvest website, but came to the wrong conclusion that HSBC funds would be hit by the £12.50 (ISA)/£25(SIPP) per quarter custody charge. On closer inspection, they are not (no custody fee), but Vanguard would be.
Having 2xISA and 2xSIPP, going fully Vanguard would cost £300+vat per annum. Still costly!!
But putting our largest ISA into Vanguard @ £50+vat per annum fee, and others into HSBC could work. Time to get the calculator out and crunch numbers.
Just downloaded their application forms.
Thanks again.
Interactive Investor don’t charge for their ISA, and offer most, if not all HSBC and L&G (inc. EM) trackers.
Is there any reason there’s been little or no mention of them in this comments thread?
I did previously look into their SIPP also, though it seemed uncompetitive, and using a different provider for some diversification seems a good idea anyway.
I looked at Interactive Investor, but it’s £120+vat pa, and they had the HSBC trackers and the L&G EM tracker, but not a low-fee property index. They also had a £300 leaving fee.
BestInvest seem cheaper, offer more funds, and (probably) cheaper to leave at £25 per asset.
It’s all down to what you want to hold, size of pot, and whether you think RDR will force you to jump ship again.
Looks like Vanguard WILL be available in January via HL, according to below. But surely, for their own reputation at least, they should have mentioned this at the same time as whispering about their new platform charges:
http://www.thisismoney.co.uk/money/investing/article-2064358/Hargreaves-Lansdown-2-monthly-charge-tracker-funds-offers-Vanguard.html?ito=feeds-newsxml
THERE IS SILVER LINING…
The silver lining to the Hargreaves’ new charging structure is the addition of Vanguard funds to its platform. Vanguard is offering the cheapest tracker funds in the UK. For example, it charges 0.15 per cent on its FTSE All Share fund against 0.25 per cent for a near-identical product at HSBC.
Vanguard’s funds have frequently ranked amongst the top-sellers at rival low-cost investment platforms like Alliance Trust. Until now, Vanguard refused to pay commission to Hargreaves to appear on its platform. Thanks to the change to a flat fee, Hargreaves has at last struck a deal.
Danny Cox added that other extreme low-cost trackers will be available on the Vantage account from January next year.
@ Ben – Alliance Trust don’t rebate index funds.
@ Gadgetmind – the figures you quote for Interactive Investor refer to their SIPP not their ISA. iii are well worth a look if you’re not thinking SIPP.
@ Steve – I do have a Fidelity tracker but not through the Fidelity platform. It’ll be very interesting if HL do offer Vanguard funds for £2 per month, no trading fees. May still not be as cheap as Alliance Trust but it will depend on number of funds you own and how often you trade. Interesting to note how well Vanguard are doing for AT though. Passive investors are on the march.
@accumulator
thanks for pointing that out – I’ve found the AT doc that contains all their funds and the rebates on those funds now:
http://www.alliancetrustsavings.co.uk/pdf/list-of-funds.pdf