There now follows a whistle-stop tour of the features to look out for when choosing the best index trackers for your portfolio.

I use this rundown as a quick checklist to help me navigate the investing minefield without being reduced to bloody stumps. Even in the relatively benign terrain of passive investing, you can too easily choose a wealth-damaging product if you don’t tread carefully.

Note: I use the term index tracker here to refer to BOTH index funds and Exchange Traded Funds (ETFs).

I’ve split the checklist into four parts (watch out for parts two – four over the next few weeks), as it would be a lot to digest in one helping. Once you’ve bought your first fund or two, you should be able to skim through the checklist at speed, just using the big blue sub-heads to keep you on track.

First, choose your asset class

Each index tracker focuses on a specific part of the investable market. Do you want to hold equities or bonds, property or commodities?

You can keep things simple with total market type funds that hold a broad mix of an entire asset class. iShares MSCI World ETF, for example, represents the entire developed world equity market in one fund.

Alternatively, you can select exposure to subsets of each asset class.

• Most equity funds diversify by geography and size.

• Bond funds mostly diversify by geography, quality, duration and anti-inflation (or not!) characteristics.

Select the right index

Knowing which index your potential fund tracks is as important as knowing which route you’re going to take to work. You can’t get to where you’re going without that underlying understanding.

Google the index to find out:

• Which asset class it covers.

• How representative of the market is it? E.g. The FTSE All-Share covers around 98% of the UK investable market while the FTSE 100 accounts for less, about 81%.

• Is the index concentrated in particular sectors, companies, or countries?

• Is it liquid? Trading costs rise for stodgy indices.

• What are the index rebalancing rules? The more companies drop in and out, the higher the turnover costs (see checklist part two).

• Is it subject to any special rules? Most indexes are market cap-weighted, but some are price-weighted or select firms by certain fundamental measures.

• Which version of the index are you tracking? An accumulating fund should track a total return index. An income fund should be compared with a price return index.

• Do the index holdings overlap significantly with others in your portfolio?

Fund structure

Index trackers breakdown into index funds and Exchange Traded Funds (ETFs).

Index funds are simpler to use and have a longer track record of doing a job for passive investors. ETFs are innovative, more flexible, are multiplying like devil spawn and require a deeper understanding to use without hazard.

Index funds sub-divide into:

• Unit Trusts
• Open-Ended Investment Companies (OEICs)

The practical difference between those two structures is negligible for passive investors.

ETFs are part of the wider Exchange Traded Product (ETP) family that includes:

• Exchange Traded Commodities/Currencies (ETCs) – track oil, gold, cattle, renminbi etc.
• Exchange Traded Notes (ETNs) – a debt instrument for tracking hard-to-reach indices. Avoid unless you know what you’re doing.
• Certificates – Essentially the same as ETNs.

For completion sake, there are also one or two investment trust trackers on the market. They’re only worth a look if you understand the complexities of trading ITs at premiums and discounts.

Replication strategy

How does a tracker mimic its index? In order of preference choose from:

• Full physical replication – The fund holds every security in the same proportion as the index.

• Sampling/Optimised – The fund holds a representative cross-section of the index because it’s too expensive to hold every security. Replication is physical, but tracking error is likely to be higher in comparison to full replication.

• Synthetic – So-called synthetic ETFs use derivatives known as total return swaps to earn the return of an index, without having to hold any of its component securities. Swaps are good for tracking error but they expose you to counterparty and collateral risk.

That wraps up the basic criteria I think about when choosing the best index trackers out there. Part two of this checklist looks at costs, part three exposes some of the lesser publicised tracker wrinkles you need to know about, and part four looks at ETF-only quirks.

Take it steady,

The Accumulator

A few good reads from across the Web.

Some people should read more 1950’s science fiction to develop a sense of imagination, as well as to appreciate the impossibility of making accurate predictions about the future, even when you earn a living doing it.

The people to whom I’m prescribing a course science fiction (three times a week) are those people who will tell you there will be no jobs left in the western world by 2020 because we won’t make our own televisions, cars, or microwaveable meals.

“What will we do?” they lament.

More than a few of these blinkered thinkers – some of whom I count among my closest friends – are at the very upper-end of the intelligence spectrum.

In fact, I’d say intelligence is a curse when it comes to having a sense of the possible.

Smart people get used to logic, plans, causation and outcomes. But life doesn’t run much like that, and the development of human technology, society, and culture even less so. The pill, the smartphone, the personal trainer, the options trade, the £100 t-shirt – nobody foresaw any of that one hundred years ago. The biggest innovation of the next 20 years will probably also be something we’ve not yet even thought of.

Less clever people are regularly bemused by the world – as well as infuriatingly sanguine about human achievements to-date. Yet this sense of inevitability, that ‘they’ will invent something to sort out the problem, isn’t demonstrably less useful or even less accurate than the intricate fables to ruin that smarter people have been intoning since the Greeks.

This isn’t to say societies don’t fail, of course. They clearly do. But it’s very rarely for the reasons the gloomier predicted. History is more random than that, and we take steps to avoid the problems we can foresee.

• Monevator motto #23: Timebombs don’t explode.

Besides, even in the field of the futuristic, what goes around comes around. In Invasion of the body hackers, a very interesting piece of futuristic navel-gazing in the Financial Times this weekend, April Dembosky writes:

The concept of self-tracking dates back centuries. Modern body hackers are fond of referencing Benjamin Franklin, who kept a list of 13 virtues and put a check mark next to each when he violated it. The accumulated data motivated him to refine his moral compass. Then there were scientists who tested treatments or vaccines for yellow fever, typhoid and Aids on themselves.

Today’s medical innovators have made incredible advancements in devices such as pacemakers that send continuous heart data to a doctor’s computer, or implantable insulin pumps for diabetics that automatically read glucose levels and inject insulin without any human effort.

Healthcare is just one area ripe for tremendous new growth, even from its currently elevated position – the quest to preserve life has already begun to deplete the extraordinary wealth socked away by the Baby Boomers, and in 50 years time the Chinese and the Indian middle classes will follow.

[continue reading…]

With Amazon’s Kindle eBook reader spreading as rampantly as a greedy European rodent in a New World ecosystem, more and more books and magazines are being adapted and republished in Kindle editions.

These include plenty of Kindle books about money and investing, although there are still lots of frustrating omissions. UK passive investors might mourn the absence of a Tim Hale’s Smarter Investing in Kindle format, for example.

But let’s consider the good news story…

You’re eBooked

Amazon says Kindle – which the cyber book peddler produces itself – is now its best-selling product. Going on all the Kindles I see on the Underground here in London, I quite believe it.

The latest generation of Kindle solves almost all the problems of the old Kindles, and are really priced to sell:

• The Kindle 3G costs £152, and as its name suggests it enables you to connect to the 3G network as well as Wi-Fi to download data. (For free, amazingly).

• The standard Kindle costs £111, and is identical to the 3G model except for the absence of that 3G connectivity. Instead, you must use a Wi-Fi network.

For anyone with a home Wi-Fi network, the cheaper Kindle is a fine option; realistically you won’t want to download ebooks on-the-go much. One sneaky benefit of the Kindle 3G though is that you can use its rudimentary web browser on the 3G network for free, which may be handy, particularly if you’re traveling in Europe and want to avoid data charges on your phone.

Either way, the clarity of text on Kindle is amazing, the ability to add notes is fantastic, and carrying all your books with you wherever you go is something you don’t appreciate until you can do it. About the only downside is the bland typography, which upsets old print lovers like myself.

When Kindles first arrived I wondered if they were a tax on reading, but now I’m sold. I love paper books, but Kindle has the edge once you toss the romance of paper overboard. I don’t think there’s much if any money saved from going digital, but I do hate clutter and having too much ‘stuff’ and Kindle deals with that. Perhaps it will save me ponying up for an extra bedroom cum library in my future house purchasing!

A dozen Kindle books about money and investing

To the money shot! I’ve dug into the Kindle Store to hunt out the following publications (they’re not all books!) that you could consider for your Kindle.

1. The Snowball: Warren Buffett and the Business of Life

One of the best books you’ll ever read about investing, dressed up as a biography of a more bizarre individual than you probably imagine. I admire the man and the detail here – but Buffett was apparently so miffed by its candor that he no longer speaks to the author. More details from Amazon.

2. The Intelligent Investor

In-between speaking fluent Latin, writing his own plays, studying the classics and seducing the women of Manhattan, Ben Graham invented all the basic tenets of value investing. The Intelligent Investor is his classic introduction, and the 60-year old book will retain its popularity on in the eBook era. More details.

3. Common Stocks and Uncommon Profits

If Ben Graham is the father of value investing and Warren Buffett his most successful pupil, then Philip Fisher is the father of growth investing – and the author Buffett read as he started sneaking off the one true path laid down by Graham. Another timeless classic that’s essential reading for anyone whose heart is set on the dangerous game of stock picking. More details.

4. Enough: True Measures of Money, Business and Life

Not many people in the UK have read this brilliant book by Jack Bogle, the father of passive investing. It’s not really a how-to guide for passive investors (you can read our articles instead!) or even a case doing so – Bogle has made that argument many times. Rather it’s a thorough review of how the financial services industry repeatedly does wrong by its customers, culminating in the recent financial crisis. More details.

5. The Big Short

The Accumulator has recounted the lessons from The Big Short on Monevator, but this isn’t a book I’d just read to learn from. Like most of author Michael Lewis’ writings, it features an incredibly compelling collection of characters, too – you soon forget you’re essentially reading about maths geeks staring at spreadsheets most of the day. More details.

6. Anyone Can Do It

As I said when I reviewed it donkey’s years ago, Duncan Bannatyne’s best-selling biography is not beautiful writing. The entrepreneur’s story isn’t half as sexy as Richard Branson’s, either, with the (seemingly) surly Scot not getting going until his 30s, and beginning to make his fortune with an ice cream van. What it is though is fabulously readable and packed with practical insights into the mind of a down-to-earth rainmaker we can all learn from. More details.

7. Free Capital

I was surprised to find Free Capital on the Kindle store. A clearly written collection of profiles of 12 private investors who’ve made at least a million from the markets – several by ‘simply’ stock picking for their ISAs – the book is another to file under Inspiration, and is rare for its British focus. The fact that it’s on Kindle shows how the device is becoming ubiquitous. More details.

8. Eat that Frog!

This book isn’t about money or investing, but it is one of the best books on effectiveness and time management I’ve ever read. Mainly because it’s one of the shortest. Where most time management books drone on for hundreds of pages, Eat That Frog! steals their best ideas and repeats them in two. It’ll make you more efficient, and pays out that most precious commodity: time. More details.

9. The Financial Times

You can now get the Financial Times on Kindle, and as I write it’s priced at just under £18 a month – a decent discount to the paper edition. There’s a free 14-day trial, too. It all updates seamlessly and reveals the future of newspapers is surely digital, but the text layout isn’t perfect. In my opinion it’s the best business paper in the world, but then I don’t read German or Japanese! More details.

10. The Economist

Sticking with periodicals, The Economist is my favourite big picture read (although I also like Prospect for its wider cultural coverage) and a frequent edition to Monevator‘s Weekend Reading slots. The Kindle edition is fine, but a bit expensive compared to the other subscription options. More details.

11. The Greatest Trade Ever

If The Big Short doesn’t satisfy your cravings for a heady mix of credit crunch shenanigans and buccaneering moneymaking on the back of it, then this recap of how hedge fund manager John Paulson made $20 billion out of thin air surely will. More details.

12. More Money Than God

I confess, I’m fascinated by hedge funds, although I’ve never invested in one as a private individual – I think in practice retail investors are unlikely to do better long-term than if we simply buy an index tracker and save some cash, due to the high fees universally charged by hedge funds and the rarity of (and difficulty selecting) enduring out-performers. But in my daydreams I’d love to run one, and until then I aspire to manage a portion of my active portfolio like a hedge fund. More Money Than God recounts the most innovative hedge funds’ market-smashing capers. More details.

Have I missed one of your favourite Kindle books about money and investing? Let us know in the comments below – particularly if it’s a book targeted at the UK market, since most I know about and like aren’t on Kindle yet.