- How to buy your first index trackers
- Choosing an investment platform: A nuts and bolts guide
- Picking an index tracker out of the investing swamp
- How to choose the best index trackers #1: Basics
- How to choose the best index trackers #2: Costs
- How to choose the best index trackers #3: Overlooked stuff
- How to choose the best index trackers #4: ETF-only features
- How to find index funds
- How to find Exchange Traded Funds
- How to buy and sell ETFs
- How to buy and sell index tracker funds
Previously we’ve run through how to open an online broker account and how to buy and sell ETFs.
Today we’re going to look at purchasing an index tracker fund.
Next stop, the world – muhaha!
[Editor’s note: I think he meant to write ‘Next step, a globally diversified passive portfolio’. Or at least I hope he did.]
What is an index tracker fund?
An index tracker fund is typically an Open Ended Investment Company (OEIC).
In normal-person speak, this means a tracker fund is set-up as a company that you can buy and sell shares of. Index trackers are ‘open-ended’ because the number of shares in the company will rise and fall when investors buy or sell them from the manager of the fund.1
Some tracker funds are still set up as Unit Trusts. This means they are structured as a trust rather than a company, and investors buy and sell units in the trust. Like OEICs these are also ‘open-ended’.
From an everyday investor’s point of view, the two flavours mostly amount to the same thing. We’ll focus on OEICs, which we’ll refer to simply as index funds from here.
Pricing
Before you buy anything it’s important to know how the market works.
Index funds are priced based on the value of their assets using a set formula. Unlike ETFs or shares, there is only once price for an index fund for all buyers and sellers.
This price is calculated once a day, at a set time (called the valuation point).
Index funds are typically traded at the end of the day (called the market close). To trade on a given day, you need to do it before a particular cut-off time.
If you place your order after the cut-off, your trade will go through at the next valuation point.
I’ll trade yer!
First we need to locate the fund we want to trade. We find it by searching for its fund code – a unique letter string given to every fund, which you’ll find on its factsheet – or else we can search by fund manager.
Below we’ve typed in ‘VVFUSI’, which is the code for one of Vanguard’s FTSE All Share trackers:
Here we can see there’s no ‘active’ price for fund. Instead, we’re given the last closing price (as at 1/10/2018).
We’re then taken through to the following confirmation screen:
(Click to enlarge the small print!)
You’ll notice we’re only confirming a total order value for our trade – £1,000 in this example – and no price. As discussed above, an index fund is only priced once a day. We won’t know the exact price we paid until the deal is done.
Because OEICs have a single price there’s no bid-ask spread, unlike with ETFs. Transaction charges are ‘hidden’ within the price. (Unit Trusts do have two prices, like ETFs.)
Aside for geeks: Most index funds use what’s called ‘swing pricing’, where the asset value of the fund is adjusted based on the volume of buyers and sellers to cover transaction charges. Historically, Vanguard used something called a Dilution Levy, which was an upfront transparent charge. This was used to cover trading costs, so that long-term investors weren’t charged for short-term trading. It was terribly misunderstood and Vanguard gave in to pressure and moved to swing pricing.
Most good brokers don’t charge a commission for trading index funds, or they charge a lower commission. This usually makes them cheaper to invest in than ETFs, where dealing fees are typically applied. No fees is a nice benefit for long-term investors looking to keep costs low, especially when you’re starting with small sums. Have a look at the super-duper Monevator Broker Comparison Table to compare charges.
When we’re happy with our order we click the appropriate boxes and send it through. After that it’s just a matter of sitting back and waiting for it to be fulfilled. The buying is done.
As with our ETF purchase in the previous article, we have to wait a while for official settlement of our trade2 but in practice you’re now invested in the fund. Your broker should supply you with a contract note for your records.
That’s it!
Buying and selling index funds is easier than trading ETFs, if only because you don’t have the pressure of a countdown and there’s no need to worry about spreads.
True, you do have to wait to know the exact price you pay with index funds, unlike ETFs.
But for long-term passive investors putting money into broad index funds, that’s no great disadvantage. Price fluctuations on a day-to-day basis are essentially random. We’re growing our investments for decades.
Inspired? If you’re after ideas about what index tracker funds to buy, check out The Accumulator’s overview of low cost index trackers.
Read all The Detail Man’s posts on Monevator.
Comments on this entry are closed.
I find myself tempted to buy one of those negative ETFs – effectively a bet that, say, the S&P 500 is in for a tumble. I shall try to resist. Or maybe just a little bit for Xmas? A sort of financial mince pie? Can one buy them in SIPPs? ISAs?
The last time I felt like this was 2007-08. I funked it because I realised that betting trades had counterparties – mainly the very banks I expected to go bust. I had not bargained for the taxpayer bailing out almost all the banks.
I suppose this time we must expect Deutsche Bank to be rescued.
P.S. The time stamp on my comment seems to be in BST.
@dearieme — Make sure you understand the maths and strategy before buying a short ETF: http://monevator.com/short-etf-maths/
ETFs and shorting are off-topic for this post though, so please make any further comments over on that article.
Thanks for the BST heads up… it always does this in winter and I’m loathe to change anything in case something in the site borks. As mostly passive investors with multi-decade time horizons I judge we can survive a little temporal displacement!
How do you find the fund code? I looked on the fact sheet for all my Vanguard funds, but can only ever find ISINs (which doesn’t allow me to auto update them on The Details Man’s performance tracker).
Hi Andrew #4,
It’s a bit of a pain – the only way I have found so far is this:
1) Go to https://www.vanguardinvestor.co.uk/ and change the page you’re looking at from Personal Investors to Financial Advisors – top row, very last entry on the right or
1) Go straight to https://www.vanguard.co.uk/adviser/adv/home
2) The HOME tab on the left of all tabs should be on view – click on Vanguard Index Funds
3) Click on the name of the index fund you want to look at
4) On the left side you can see the following categories:
– Costs,
– Key Fund Facts
– Prices
– Fund codes
OR
If you know you’re only going to look at Index Funds anyway you could go straight there:
1) https://www.vanguard.co.uk/adviser/investments/product.html#/productType=indexfunds
Regards, Pinch
@AndrewM, if you’re talking about the portfolio returns spreadsheet that The Investor shared in the Weekend Reads then sadly Google Finance doesn’t return prices for mutual funds anymore. It looks like it’s killed off for good. Instead, you can use the ‘ImportHTML’ function to pick up prices from elsewhere (such as Morningstar or Vanguard itself).
Now with respect to Vanguard, the issue is that you can’t see this stuff anymore on the “personal investors” website. Instead, what you need to do, is go up in the top left and change it to “financial advisers”. That way you’ll be able to get the codes. It’s a bit of faff, I don’t know why they changed it.
Talking about the codes, typically the “MexID” works for finding the fund when needed. For the FTSE U.K. All Share Acc, it’s VVFUSI as mentioned in the post. The ISIN for the fund is GB00B3X7QG63. You can convert ISINs to SEDOLs by lopping off the first four characters and the last character. Thus the SEDOL for the fund is: B3X7QG6. A rule of thumb, if the MexID doesn’t work, try the SEDOL (or vice versa).
Really interesting article. One question I have is that you imply that index funds have the edge on ETFs. But from my experience the platform fee for holding funds is often more expensive than if you trade ETFs. Taking Fidelity as an example, they charge 0.35% for holding funds but their fees are capped at £45 for exchange traded instruments (https://www.fidelity.co.uk/investing/fees). So when you get above a certain level it’s much cheaper to invest in ETFs than index funds.
Hi: I’m new to this site and would be grateful if anyone could help me out.
When calculating the tracking difference of funds from their factsheets, I’ve noticed that, after fees, some funds seem to slightly outperform their index.
For example, Vanguard’s FTSE Developed World ETF returned 0.10% a year above its index after fees from 2015 to 2017, while the FTSE Developed World ex-UK Equity Index Fund returned -0.13% a year.
An extra 0.23% a year or so would be quite significant, but is this a real effect that’s likely to persist?
For what it’s worth, it seems it is mostly the ETFs that slightly outperform, and the index funds that lag. Perhaps ETFs have favourable tax treatment compared to index funds?
Or are certain funds’ factsheets presenting returns in a misleading way, or something else?
Many thanks to anyone who could explain this for me.
@Mark — We’ve written quite a bit about tracking difference over the years:
https://monevator.com/tag/tracking-error/
(Note there are two pages of articles — click Previous at the bottom to see the next four).
I’m not 100% sure whether we cover your exact question in there, and I’m not our passive fund expert (I’ll ask my co-blogger @TA if he can comment.)
In short, tracking difference can arise from a variety of places, such as the costs of running the fund and mismatches between the method chosen to replicate the index return and the index return itself. You need to look over several years at least to get a sense of consistency. It’s probably a better policy to select a fund that tracks as closely as possible for as long as possible, since that’s what you want with a tracker, rather than selecting one that appears to have some edge over the market, which could indicate a tracking mismatch that could be reversed.
(To be clear though I’d happily pick the Vanguard fund in this case and take my chances. I wouldn’t bank on that specific pair of divergences lasting.)
@JP – That’s a fair comment and something I touched on in the sister post on ETFs: https://monevator.com/how-to-buy-and-sell-etfs/
@Mark – As TI says, the important thing to look for is long-term consistency at tracking the index.
In terms of why ETFs tend to have positive or, for some of the larger fund providers, smaller tracking errors, is down to how ETFs are structured. Their structure is very efficient which provides a lot of opportunities to offset costs.
Effectively an ETF works by the fund manager going to a bank/intermediary and asking them to buy all the securities it needs. In exchange for the securities, it gives the bank units in the ETF which it can then sell for a profit. Depending on how the price of the ETF relates to the cost of the underlying securities, the bank can sell its ETF units or buy the underlying securities in exchange for more ETF units. The bank will in effect be playing market maker and arbitraging away any difference between the ETF price and the index. Thus reducing tracking error.
The reason why ETFs can often produce positive tracking errors is because the fund manager isn’t doing very much trading of securities (unlike with an index fund). The bank does most of the transacting. What’s more, the bank will pay fees to the fund manager for the administrative work in buying and selling ETF units. As you might infer, by not actually buying and selling securities, this means the ETF itself typically incurs lower tax charges. Though that is more of an issue for US ETFs rather than European ones which are typically domiciled in a low-tax jurisdiction – Ireland, Luxembourg etc.
Of course, it’s a little bit more complicated than that. But for those wishing to find out more, have a search online for: ETF creation redemption process.
Those two products have different holdings. Could easily be down to some deviation in holdings versus the index that happened to favour one fund or the other. These are the sort of differences that I’ve personally given up worrying about. As long as a fund isn’t persistently tracking by more than its fees, or lagging competitors by a wide margin then I sleep easy. Vanguard are particularly good at tracking but nobody can say whether any advantage will persist. The numbers tend to move around. Also watch out for product factsheets using different time periods or currencies or anything else that can turn apples into oranges.
@ TI and the Details Man – thank you for your replies.
Reading through the articles and comments on tracking error reinforces for me the importance of a tracker hugging its index tightly before fees over preferably five or more years.
And with many of the ETFs having existed for only three years, it’s easy to fool myself with randomness.
Getting some FSCS protection for UK-based index funds is an advantage, too.
On the other hand, across different regions Vanguard’s ETFs all seem to do about as well as or better than its index funds according to the factsheets.
I did read on this site that an ETF will often compare itself to the net total return version of its index, which doesn’t have the tax advantages of the ETF. But I think that if that manifested as positive tracking error for an ETF but not an index fund, that would be a genuine advantage for the ETF, and not comparing apples with oranges?
The potential modest upside, and the comments of TI and the Details Man, make me more inclined at the moment to go with, say, a Vanguard or iShares ETF with better historical tracking difference, even if it is based in Ireland.
(I somewhat maniacally created a spreadsheet with tracking and other data on many different funds. Here’s a link in case anyone else finds it helpful: https://docs.google.com/spreadsheets/d/1CbAq6X1-DUxi_L58VNGcBuSFe_bgppLTO2vvMUMdux4/htmlview#.)
I’ve not come across any solid evidence to suggest that ETFs domiciled in Europe have inherent tax advantages over index funds. Would love to see some if anyone can point me in the right direction. Comparing your product to an index that takes a tax hit you can avoid is more of an accounting trick. It’s possible the structure of an ETF enables its managers to avoid more withholding tax than index funds but I haven’t seen anything on that. If we had 10 years of returns showing that a category of ETFs convincingly beat equivalent index funds that’d be worth knowing. But even in the US, a much more transparent, analysed and developed market than our own, there aren’t credible voices suggesting one over the other. Unless you count William Bernstein or Jack Bogle who argue for index funds over ETFs – on grounds of investor psychology and product simplicity. Wait a second…
@TA – thank you for your comments.
Ah: I misunderstood about how ETFs benchmark themselves: thanks for clearing that up.
OK: it looks like I should mostly disregard small tracking differences between otherwise decent-looking funds, relative to other considerations.
That said, I’d still like to cut fees if feasible. Even a 0.25% platform-and-fund fee means that, assuming a (3 to 5)% annual return, between 0.25 / 5 = 5% and 0.25 / 3 ~ 8% of the portfolio is effectively spent just to invest the other (92 to 95)%, which is quite a lot.
Fixed platform fees would diminish in percentage terms as the portfolio grows, but not the fund fees.
Perhaps a portfolio of 10 to 20 somewhat randomly chosen large-cap stocks with international exposure would basically mimic an index portfolio à la Kroijer, but without the expense ratios.
On the other hand, more diversification might be worth another 0.15% a year or so.
Hmm … I’ll probably go with Lars, but I shall have to mull this one over.
Cheers all – very helpful clarifications. How odd that Vanguard doesn’t make this more clear!
VVFUSI cut off time is 11.15am based on the above, right? So if I purchase now, I’ll get this evenings valuation point?
I realise the above is dated, just using it as an example, especially as I use iWeb too and find things endlessly confusing in terms of cut off times etc