What is an exchange-traded index tracker fund (ETF) and how does it work?
An exchange-traded fund (ETF) index tracker is a fund that tracks an index like the FTSE 100 and trades on the stock exchange like a share making it more liquid and flexible than a unit trust. A unit trust, for example, is only priced and traded once a day.
Types of ETF:
There are three types of ETF available
Physical ETF
A physical ETF tracks an index (such as FTSE 100) by directly buying the underlying securities of the relevant index, this enables the ETF to replicate the index very closely.
Synthetic ETF
A synthetic ETF does not invest in actual shares instead it enters into an agreement with a third party (typically an investment bank) to swap the performance of a basket of investments for the exact return of the index being tracked.
Sampled ETF
A sampled ETF is where a sample of holdings in the underlying index are purchased rather than all the holdings. The sample of the index used is designed to reflect the overall index performance.
What to consider before buying a FTSE 100 index tracker ETF
An index tracker ETF is what is known as a passive investment and will reflect the fortunes of the index it is designed to track. The price of an ETF will tend to reflect the ups and downs of the relevant index so will suffer disproportionately if a particular sector, that makes up a large part of the index, goes through a downturn. Investing in an index tracker ETF is seen as a long term investment so that any dips in the relevant index will have time to recover within your investment timescale.
Costs
Whilst the charges involved with an ETF are generally lower than with actively managed funds you should still check the charges of an ETF versus its peers to ensure you are getting value for money. In order to invest in an ETF you need to use an investment platform to facilitate and administer your holding. These investment platforms levy their own charges on top of those levied by the ETF itself. Therefore you need to ensure that you keep additional charges to a minimum. Unlike when you invest in a FTSE 100 tracker fund (i.e. unit trust), most platforms levy an initial transaction charge when you invset in an ETF. Below I look at the cheapest investment platforms for investing in a FTSE 100 ETF via a Stocks and Shares ISA, SIPP or general investment account.
Tracking error
An ETF's tracking error is a measurement of how much the ETF deviates from the actual index it is tracking, such as the FTSE 100. This tracking error can be caused by fund costs, money flowing in and out of the fund or changes in the constituent shares making up the index. The lower a fund's tracking error the better, as it means it better reflects the performance of the relevant index it is tracking.
The cheapest way to invest in a FTSE 100 index tracker ETF
As stated earlier investing in index tracker ETFs is cheaper than investing in actively managed funds due to the additional management that is required with an actively managed fund. When comparing index tracker ETFs you should compare the ongoing charges figure (OCF) as they differ from ETF to ETF. This figure represents the total cost of running the fund and includes administrative costs such as maintaining records, producing reports and calculating the daily unit price as well as paying for any research that goes into deciding which assets to buy and sell.
Below are three of the cheapest FTSE 100 tracker ETFs which have competitive OCFs
- OCF - 0.07%
- No other fees payable
- Tracking error - 0.70
- ETF type - Physical
iShares Core FTSE 100 UCITS ETF GBP (Acc)
- OCF - 0.07%
- No other fees payable
- Tracking error - 0.70
- ETF type - Physical
Vanguard FTSE 100 UCITS ETF (GBP) Accumulating
- OCF - 0.09%
- No other fees payable
- Tracking error - 0.70
- ETF type - Physical
Of course, in order to invest in a fund you need to use an investment platform or broker. The table below shows the total cost, for differing portfolio sizes, if you were to invest in the Vanguard FTSE 100 UCITS ETF via an ISA (or general investment account) or a SIPP with some of the most popular and cheapest investment platforms.
Cheapest way to invest in a FTSE 100 ETF within an ISA / General Investment Account
| Platform | Single trade cost | Regular investing cost | Platform Fee | Vanguard OCF fund charge | Annual charge on £10,000 | Annual charge on £25,000 | Annual charge on £50,000 | Annual charge on £100,000 |
Annual charge on £250,000
|
| Hargreaves Lansdown* | £11.95 | £1.50 | 0.45% per year capped at £45 | 0.09% | £54 | £67.50 | £90 | £135 | £270 |
| Vanguard Investor | £7.50 | n/a | 0.15% p.a. capped at £375 | 0.09% | £24 | £60.00 | £120 | £240 | £600 |
| Interactive Investor* | £3.99 | n/a | £4.99 or £11.99 per month | 0.09% | £68.88 | £82.38 | £104.88 | £233.88 | £368.88 |
| A J Bell* | £9.95 | £1.50 | 0.25% max. of £25 per qtr. | 0.09% | £34 | £85.00 | £170 | £190 | £325 |
| Fidelity* | £10.00 | n/a | 0.35% - up to £249,999 capped at £45 | 0.09% | £44 | £67.50 | £90 | £135 | £270 |
Cheapest way to invest in a FTSE 100 tracker within a SIPP / Pension
| Investment Platform |
Single trade cost | Regular investing cost | Platform Fee per annum | Vanguard OCF fund charge | Annual charge on £10,000 | Annual charge on £25000 | Annual charge on £50000 | Annual charge on £100,000 |
Annual charge on £250,000
|
| Hargreaves Lansdown* | £11.95 | £1.50 | 0.45% up to £250,000 | 0.09% | £54 | £135 | £270 | £540 | £1,350 |
| Vanguard Investor | £7.50 | n/a | 0.15% p.a. up to £250,000 | 0.09% | £24 | £60 | £120 | £240 | £600 |
| Interactive Investor* | £3.99 | n/a | £12.99 per month | 0.09% | £164.88 | £178.38 | £200.88 | £245.88 | £380.88 |
| A J Bell* | £9.95 | £1.50 | 0.25% on first £250,000 | 0.09% | £34 | £85 | £170 | £340 | £850 |
| Fidelity* | £10.00 | n/a | 0.35% - up to £249,999, 0.20% - £250,000 to 1 mill. | 0.09% | £44 | £110 | £220 | £440 | £725 |
As you can see from the above information the decision about which investment platform to use can make a significant difference to your returns over time. Also, many platforms have the same charges for both ISA and SIPP but not all, so it may be cheaper to have your ISA with one platform and your SIPP with another as shown above.
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