- Monevator - https://monevator.com -

Index fund tactics to save you a bundle

There aren’t enough low-cost index funds [1] available to UK investors. This comes as a shock when you’ve read all the books proclaiming passive investing [2] 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 [3]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 [4] play havoc with small investment sums. And while Vanguard’s cut-price index funds [5] offer another route to salvation, that way too is blighted by trading fees.

The solution is a no trading fee portfolio:

Avoid trading fees [6]

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 [7] index funds:

Domestic equity
HSBC FTSE All Share Index – TER1 [8] 0.27%

UK gilts
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 [9] that cover all four corners of the developed world when combined.

Happily, the TER averages out at a reasonable 0.325%2 [10], 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 [11]. But whatever amount you decide to invest overseas, your developed world equity mix should take its cues from an appropriate index [12].

For example, Vanguard’s VVDVWE fund [13] tracks the ‘FTSE All World Developed ex UK index’ and offers the following guide:

Greater diversity

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 [14]. 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 [15]. 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 [16] or fund supermarket [17]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.

And finally…

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 [18] 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,

The Accumulator

  1. Total expense ratio – see my previous warning about high TER [23] hazards [ [24]]
  2. Non-weighted [ [25]]