There aren’t enough low-cost index funds available to UK investors. This comes as a shock when you’ve read all the books proclaiming passive investing to be easy – just pick some recommended index funds to cover the main asset classes, batten down the cost hatches, and settle in for the long haul.
But those books are American. In America, trackers are as cheap and plentiful as burgers and cars. It’s much harder to put together a decent passive portfolio in the UK – especially if you’re a small investor.
If you’ve only got a few hundred pounds to put away every month and you need the discipline of drip-feeding, then you’re up against two big problems.
Problem 1: How to diversify
Most UK index funds cover domestic equity – the famed FTSE 100 or All-Share indices. Beyond that, few market segments can boast two funds, or even one.
Be reassured: You haven’t missed some secret valley of the index funds where other passive investors are partying. The choice really is miserable.
I know a number of people who’ve been stopped in their tracks at this point and given up on their DIY investing dreams.
Problem 2: Trading fees
ETFs are the recommended alternative. Fill your boots. ETFs are as common as kebab vans.
But ETFs present a big problem for small investors. The flat-rate trading fees play havoc with small investment sums. And while Vanguard’s cut-price index funds offer another route to salvation, that way too is blighted by trading fees.
The solution is a no trading fee portfolio:
The No Trading Fee portfolio
Even with our limited UK choices, you can rig up an index fund-only portfolio that’s reasonably diversified and avoids trading fees. It’s not perfect, but it’s good enough to get a small investor started and way better than giving up.
My suggested portfolio contains the following recommended index funds:
HSBC FTSE All Share Index – TER1 0.27%
L&G All Stocks Gilt Index Trust – TER 0.25%
UK index-linked gilts
L&G All Stocks Index Linked Gilt Index Trust – TER 0.25%
Developed world ex-UK equity
HSBC American Index – TER 0.28%
HSBC European Index (excludes UK) – TER 0.37%
HSBC Japan Index – TER 0.28%
HSBC Pacific Index (excludes Japan) – TER 0.37%
Why I’ve suggested these funds
The domestic equity and bond fund choices are straightforward, and offer a solid foundation for a passive portfolio.
The next move is to diversify equity beyond Blighty’s shores. The only way to do this and avoid trading fees is to roll your own developed world equity (excluding UK) fund. Mine here is built from individual HSBC index funds that cover all four corners of the developed world when combined.
Happily, the TER averages out at a reasonable 0.325%2, which is less than the nearest equivalent ETF and only slightly more than Vanguard’s all-in-one fund (VVDVWE) that rocks a 0.3% TER.
Mix according to an index
How you divvy up your portfolio depends on your goals and attitude to risk. But whatever amount you decide to invest overseas, your developed world equity mix should take its cues from an appropriate index.
For example, Vanguard’s VVDVWE fund tracks the ‘FTSE All World Developed ex UK index’ and offers the following guide:
- 56% US
- 24% Europe ex UK
- 10% Japan
- 10% Pacific
Once you have your standard No Trading Fee Portfolio up-and-running, the next move would normally be to diversify into property or emerging markets.
But in the UK it isn’t currently possible to invest in a property tracker without turning to ETFs.
One answer is to save a proportion of your investment funds in cash every month until you’ve accumulated a decent lump sum. Then invest the whole lot into a property ETF in one go. This reduces the impact of trading fees as a percentage of the money you invest.
While drip-feeding is a useful technique, its real potency is as a psychological aid rather than as nitro for your investing returns. There’s no need to be exclusively wedded to the idea.
The cheapest emerging markets option is Vanguard’s VIEMKT index fund. The usual trading fee caveats apply, but again, you can use lump sums to deal with this.
However, hot off the launch pad comes L&G’s Global Emerging Markets Index Fund. It seems expensive, with an estimated TER of 0.99%. But as you don’t need to pay trading fees, the cost differential between this fund and its competitors is fairly minimal.
With the ink barely dry on the factsheet, the fund’s asset holding and performance data are sketchy to non-existent right now. I’d let this one settle down first, but at least it shows that the UK index fund market isn’t totally inert.
Where to buy
To put the plan into action, get a stocks-and-shares ISA from a broker or fund supermarket that doesn’t charge trading fees for funds (most don’t) or an annual management charge (many do, but avoid them by using the links above).
You could fall foul of £50 per fund minimum contributions, depending on your monthly investment sum. So keep in mind, you don’t have to buy every fund at once. You could buy one or two funds until you’ve reached your asset allocation target, then switch to fill up the rest.
If the whole developed world equity workaround feels like a fag, then I’ve got one final suggestion.
You can buy developed world and emerging market exposure in one ETF swoop with db x-tracker’s FTSE All-World ex-UK (XWXU).
The TER is 0.4% and if bought via a regular investment scheme then trading fees can be slashed to £1.50. That would amount to a reasonable 0.5% initial cost, if you invest £300 per month.
No one said it was gonna be easy. Apart from the books.
Take it steady,
This article and your last (on withholding tax) are extremely useful, thanks. I’m looking to construct a diversified index-only portfolio with very small sums to get my teenage daughter started so this is bang on the button. Re the ‘minimum £50’ rule, interactive investor (www.iii.co.uk) will let you invest as little as £20 per month and £20 per fund.
Another fantastic article, many thanks – I’m hooked.
I have a suggestion for your upcoming review of the different investment platforms/brokers etc. You could present a few use-case scenarios that you view as plausibly representing a good proportion of investors/readers, and trace how the given use-case usage patterns would impact on overall fees and costs over the course of a year.
For instance, “The Accumulator”, “The Investor”, and maybe “passive investor + active investor split”, something like that :-). I imagine different fee structures and hence different platforms would be suitable given a particular investment style.
Another point I’m interested to have clarified is the impact of sales and exit fees, I’ve found the descriptions of what the impact is rather vague. It particularly worries me that it is extremely expensive to leave a broker and move to another. For instance, there is little preventing the broker from introducing excessive fees and charges for trading some time after you join – but ensuring that their exit charges are high enough that it does not make financial sense to flee to a competitor.
I have to say, I share in your disappointment that Vanguard funds have yet to appear on any half-decent platforms. I enquired to an iii employee about whether they were going to introduced, and they stated that they’d find out and get back to me if they were – and based upon the lack of any response I assume that isn’t happening.
I would actually go far as to say that most platforms seem to be overwhelmingly disappointing in terms of design and speed. As someone who works as a programmer I find this particularly disappointing; large amounts of computing power for relatively small expense is readily available, and the poor user interface experiences are just unforgivable. Maybe a fresh set of minds need to come and revolutionise the area ;-).
@Tyro I think the minimum £50 rule is primarily referring to the funds themselves, rather than the platform – many insist on a minimum £50 investment which has precedence over the platform’s minimum investment amount.
Great post TA. I can only dream of a TER of 0.325%.
One of the key elements of my portfolio is to minimise fees and I can only manage a TER of 0.6%. I’m largely hindered by my rip off company pension fund which charges me a TER of 1% for tracker funds.
.-= RetirementInvestingToday on: Is Brisbane Cooling – Australian Property Market – November 2010 Update =-.
Great article and wealth of information (excuse the pun!). I think something to look into is to use Fidelity for buying these HSBC index funds – they offer a free phasing service which drip feeds your funds over 12 months for free!
PS: Now my daughter’s sorted (see my last comment), any chance of an ‘income’ version of your post for my mother?
Ooh, another good find, a cheap-ish EM tracker fund in unit trust form is very good news, thanks for that. Well done L&G. (your link is broken though!)
Thanks all. Those article suggestions should keep me busy! Keep ’em coming.
@ Marc – Like the idea of tackling how different investor styles would impact on cost. Also, Vanguard Europe don’t pay distribution fees to the retail platforms which is why they don’t appear on many. I guess Vanguard will need a lot more leverage in the European market before the platforms give in.
@ RIT – I’m not far behind you in the company pension stakes. It’s 0.7% for trackers in mine.
@ Frugal – I just had a quick look at the Fidelity blurb on their Phasing service and it’s a little vague. It should be free to invest in funds anyway. Is this just their way of enabling you to set up drip-feeding on a convenient auto-pilot?
@ Tyro – You’re absolutely spot-on. My mum needs an income version too. She’s terrified of being in anything but cash and I’m struggling to convince her that inflation is as big an enemy as she faces.
@ Lemondy – weird about the link. I just tried it and it worked.
Tried the link again and it didn’t work. I suspect meddling by The Investor
— Update: Links works now! —
Yes, sorry, the link is being odd and inconsistent. Will fiddle a bit more.
I think I’ll do a specific post on this fund tonight. I’ve mentioned it to three people in the last 48 hours.
Hey there. Yeah the Fideilty phasing is all about drip feeding on auto-pilot without additional trading fees so you can pound cost average.
@ Tyro – thinking about the income side of things, have you seen Vanguard’s FTSE UK Equity Income Index Fund? http://www.vanguardinformation.com/international/pdfs/A4_F9204UK.pdf
“My suggested portfolio contains the following recommended index funds:…”
Your suggested portfolio and my actual portfolio are identical!
However, here’s an issue I haven’t yet resolved. At some point, I’ll want to sell a chunk of these nice cheap HSBC stock funds to realize my annual capital gains allowance. However, I don’t want to be out of the market for a month or more. The problem is, then, where to go in the meantime, since these HSBC funds really are the only place you’d want to be for the long haul.
For UK funds, it’s easy; either Fidelity Moneybuilder UK Index, or shuffle between HSBC all-share and FTSE 100/250 funds.
For the others, though, there’s really no obvious substitute. The best I’ve found so far is L&G International Index Trust, which ex-UK cap weighted, so matches the weights of the non-UK HSBC funds I hold. The L&G TER is 0.89% though, so it’s a lot worse than sitting in separate HSBC funds if you wind up in it long-term for some reason Switching back to HSBC after 31 days is probably the way to go, but has some slight risks — one could recognize further capital gains and go over the allowance, say.
Bed-and-ISA isn’t really an easy option, since my ISA holdings are largely bonds for tax efficiency, and aren’t immediately switchable.
Am I missing any better answer for this? A better (set of) substitute fund(s) for EU, US, Japan and Pacific holdings, perhaps? Or is this rather icky compromise perhaps the best that is possible at the moment?
Sounds like you’re living the dream 😉 You haven’t missed any no-commission index funds. The only alternative would be to buy into Vanguard index funds (which I’m pretty sure you know about given your fine work on the Boglehead forum) and then stay in them so you only incur the trading fees one way. Or an ETF of course.
Can someone kindly help me please.
I have two young children and I want to open ISA’s for both of them. I can only invest £35 each a month. From what I understand index investing is the best way to go on that budget. Can you advise which junior ISA is best for passive index investing? Further, do you have any recommendations re: index funds to invest in?
@Sadiq — Hi, we can’t give individual recommendations/advice for a host of good reasons. However we have written several articles you might find useful reading in your research: