You want to invest in an index tracker, but doing a Google search for one is like parachuting out of a plane and into the thick of the Amazon jungle. You’re likely to sink up to your pith helmet in the swamp of choices, claims, and small print competing for your attention.

As a new passive investor taking your first steps in this environment, you don’t need a tracker – you need a map.

Waypoint 1 – Searching for an index tracker

Many investors select funds using the search tools of their broker. I prefer to use an independent fund-screener like Morningstar, since no one investment platform coughs up the whole of the market.

Refining your search requires differing tools and techniques depending on whether you’re looking for index funds or Exchange Traded Funds (ETFs). Here’s some handy search tips for both:

• Index funds
• ETFs

Waypoint 2 – Recognising your quarry

Picking out index funds from the morass requires sharp eyesight because they’re just lumped in with all the razor-clawed, actively-managed beasties we’re trying to avoid.

Life would be easy if search tools offered a handy ‘tracker-only’ tick box. But such an easily implemented, investor-friendly feature is mostly absent (although TD Direct have one in their Fund Screener). What we’ve got instead is the financial services equivalent of placing cheap, own-brand products on the bottom shelf of the supermarket aisle.

The most reliable tracker-spotting technique is to look for funds with the word ‘index’ in the title. As in ‘HSBC FTSE All Share Index fund’.

Not every fund with index in the title will be a tracker, but other clues can be found in the Ongoing Charge Figures (OCF) – sub 0.5% suggests a tracker – and in the fund’s factsheet (more on this below).

Adding to the profusion of confusion, identically named funds breakdown into sub-species such as:

• Institutional
• Non-institutional
• Accumulation
• Income

Institutional funds sport cheaper costs but are aimed at giant pension funds and the like. Beer money investors like you and me usually don’t get a look in.

There are weird exceptions to the rule. Some investment platforms have the muscle to make institutional funds available to retail investors en masse. So if you’ve spotted a particularly juicy looking institutional product, it’s worth searching for it via a couple of different platforms to see if you strike lucky.

As for accumulation and income funds, they are two different classes of the same product. The designation refers to the fund’s treatment of dividends.

• An income fund pays out dividends into your account, as you might expect.

• An accumulation fund retains dividends, using them to swell the share price. It’s the equivalent of reinvesting your dividends into the fund – a very good idea as that’s a major component of long-term investing returns. Accumulation funds also save you paying the dividend reinvestment charges your broker loves to levy.

Look out for acc and inc suffixes in a fund’s name (as listed by your platform) to spot the difference.

The ETF equivalent of an accumulation fund is generally called a capitalising ETF, while a distributing ETF pays out dividends like an income fund.

Waypoint 3 – Compare trackers

You can make sure a fund tracks the asset class you require by reading its Morningstar Fund report (click on the fund’s name in the fund screener to access). The report reveals important information on the fund’s benchmark, fees, performance, holdings and so on.

You can also quickly compare similar funds with Morningstar’s handy Fund Compare tool – enabling you to scrutinise characteristics side-by-side.

One important characteristic are fund charges. Smoke and mirrors are two of the industry’s favourite tools for diverting attention away from the impact of charges. Different layers of charges can make it hard to directly compare funds, but you can level the playing field with a Fund Cost Comparison calculator.

Waypoint 4 – Due diligence

Once a fund is ticking your boxes, it’s time for a trip to the individual fund provider’s website to immerse yourself in the literature. Take a deep breath and read all the documentation posted against that fund:

• Factsheet (click on the link to find out how to decode a factsheet)
• Supplements
• Prospectus (you’ll need a law degree to understand much of this)

Read as much as you can to gain a deeper understanding of the fund. The advantage of using a fund’s own website is that you’ll access the most up-to-date literature – hopefully weeding out some of the errors that bedevil aggregator sites like Morningstar.

The fund’s factsheet should also definitively reveal whether you’re dealing with an index tracker. A tracker’s stated profile or strategy should outline an objective that’s something along the lines of ‘tracking or matching its benchmark’. If you’re still not certain by time you’ve read all the documentation then the fund is probably not a tracker.

Waypoint 5 – Buy it!

All the hard work’s done and it only remains to place an order for your shiny new tracker with your fund supermarket or discount broker.

Make sure they carry it by searching their website using the fund’s ISIN code.

If your target fund isn’t listed on your dealer’s website, and you don’t want to use multiple investment platforms, then there’s one last hope: get on the phone. As Monevator readers William and Ben have noted: some platforms don’t list all available funds online, but they will deal in the missing products over the blower.

If you’re still stuck when it comes to picking index trackers then take a look at Monevator’s Slow & Steady model portfolio. It’s a good short-cut to a shortlist.

Take it steady,

The Accumulator

Good reading from around the Web.

I Ctrl+C copied the URL of an article on Oblivious Investor this week to forward it to my co-blogger, The Accumulator, only to open up my email folder and find he’d already emailed it to me.

After that, it wouldn’t only have been rude if I hadn’t made it my post of the week. It would probably have been bad luck!

In the article, the site’s guest blogger highlights a new breed of ETF that delivers returns based on the spin of roulette wheel:

Index roulette ETFs, such as Roquefort’s ROQ, simply bet on red and black equally. Roquefort uses random numbers generated by a proprietary atomic decay device, and cites academic research that claims this reduces the standard deviation compared to traditional selection methods.

Roquefort also offers two chromic strategy ETFs: REDS, which always bets on red, and BLAK, which always bets on black. Stoker notes that these are riskier: “Be sure you know which color you like before investing.” Roquefort has just introduced OO, which bets on the double zero. The potential for 3500% returns is attractive, but Roquefort notes that due to volatility it may not be suitable for all investors, only for better-than-average investors like you.

There’s plenty more in that vein. Obviously (I hope!) it’s a satire of spurious investment products created to be sold, not to deliver returns.

Sticking with gambling, long-time Monevator reader Niklas Smith highlighted an academic paper that considered whether poker was skilful or not. The researchers argue poker is not gambling, because a small subset of skilled players competing in the 2010 World Series of Poker achieved positive returns, at the expense of less skilled losers.

Niklas highlights the fun bit for our adventures in investing:

The economists say that similar tests of persistence in returns have also been used to detect whether mutual-fund managers have genuine expertise. In contrast to the case of poker, they point out, those tests have tended to find “little evidence of skill in this domain”.

That means that you can’t reliably choose a fund manager who will outperform the market, but you can choose a poker player who will outperform. Perhaps it’s time to start demanding fund managers and investment advisors get lottery licences?

Alternatively, perhaps fund managers should be forced to call themselves exciting poker-style names like Volatile Vince, Leveraged Lucy, Double-Dip Dave, and Dave ‘The Churn’ Dudley.

[continue reading…]

One of the troubling trials the rich face is deciding when to dial back on wealth accumulation to focus on wealth preservation.

Icarus flew too close to the sun, and plenty who’ve made fortunes have lost them, too, when instead they could have lived out their days like Scrooge McDuck in a bathtub filled with dollar bills.

Much too young

On the other hand, given how quickly life expectancy is increasing (though not quickly enough for me!) and the ease with which a champagne (or even a cava) lifestyle can become an everyday habit, others adopt excessively conservative strategies too soon.

Perhaps the young-ish and rich-ish are not as greedy as they’re cracked up to be? I’ve known high-flying 30-something investment bankers to keep their money entirely in cash, bonds, and their West London property. Not a share in sight!

Sometimes they blame the onerous trading rules of their firms, but that’s hooey. The truth is once they’ve made their ‘nut’, they want to squirrel it away, as opposed to correlating their net worth even more with their market-related jobs.

You’ve got to lose to win

Protecting what’s yours may be sensible when you’re raking in six-figure bonuses each year. Didn’t Warren Buffett say the first rule was not to lose money?1

True, but you and I aren’t made men at the last Wall Street bank standing, and you’re probably not Warren Buffett, either. Buffett can apply his loss-avoiding rule by spotting a final puff in an investing cigar butt. We mere mortals have to open cash ISAs to play safe, and that will hit our returns.

Most of the past decade was unusually kind to cash savers. But over the long run, history is clear — if you’re aiming to grow your way to wealth through modest savings and compound interest, then you need to forsake the short-term preservation of wealth for the potentially higher rewards (but greater volatility) of equities.

To give a simple example of how you could split a portfolio and expect very different results, according to Moneychimp’s standard deviation calculator:

• A 75% cash / 25% equity split predicts a return of 4.5%, with a volatility of 3.75%

• A 50% cash / 50% equity split predicts a return of 6% with a volatility of 7.5%

• A 25% cash / 75% equity split predicts a return of 7.5% with a volatility of 11.25%.

You pay a very high price for sleeping more soundly at night. The 7.5% return from the most volatile equity-dominated portfolio might not sound that much more lucrative than the 4.5% you’d get from the 75% cash-dominated one, but turning to our compound interest calculator we see:

• Low volatility, smaller returns: £10,000 a year sunk into the low return cash-dominated portfolio would be worth £638,000 after 30 years.

• High volatility, bigger gains: £10,000 a year invested into the high return equity–dominated portfolio could be worth £1,112,000 after 30 years.

The lesson: For most people, concentrating on reducing volatility to protect their net worth too early will greatly cap their returns.

Volatility is the price we pay for chance of a superior final outcome. But once you’ve made what you would consider enough money, this flips and you’d rather not lose it.

Target acquisition

To see just how hard it is to plan how much money you need, have a play with FireCalc’s returns simulator to see how long your money could last in retirement. It uses US data but the general principle applies in the UK.

Start with too small a nest egg, or experience a bad run of luck with a risky portfolio, and you can be left with nothing to explain to St Peter – but many years in poverty before you have to.

How much is enough? I don’t have an answer – however much I need, I’m not there yet!

True entrepreneurs like Branson or Bannatyne will certainly never be satisfied, but then they’re in it for the money like a scorecard. Nearly everyone else will find money after a certain point does not buy more happiness, and the law of diminishing returns kicks in.

A good aim for most of us mere mortals is to have enough to replace your salary with a diversified investment income – one with a decent proportion of real, inflation-sensitive assets like equities and commercial property in the mix, to keep you going long-term.

Complicating the timing of the shift to wealth preservation, if you can ride out the ongoing volatility there’s a good case for keeping some equity exposure even in your old age, perhaps via income investment trusts or a HYP, to further guard against inflation.

Income tends to be much less volatile than capital2. If it’s too soon to worry about preserving the latter, then concentrating on the former while accepting the capital will fluctuate may be a practical compromise.

Happily wealthy every after

If you continue to work and save after you reach your income target – or if your investments do better than expected, sooner than expected – then you can look to reduce risk a little by allocating still more money to your income fund in total, but directing a greater proportion of it towards safer assets like government bonds.

Think you’re rich enough already? Then switch to preserving your wealth, and work too on simplifying a few of your tastes to have a margin of safety!

1. The second rule is, of course, not to forget rule one. [↩]
2. Interest on cash aside [↩]