The best investment strategy - even for passive funds
Investors are often told that that the best investment strategy is to buy cheap index tracker funds because funds run by managers (so called actively managed funds) rarely beat their benchmark index over the long term. However there is a fundamental flaw in this statement as is it assumes you buy and hold your investments forever. A buy and hold strategy is never the most profitable strategy, whatever you buy. The reality is that there is an incredibly simple investment strategy which you can employ using both cheap tracker funds as well as active managed funds that will outperform the market and professional fund managers.
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Best tracker funds for the long term
Assuming you want to buy and hold for the long term the best index tracker funds will depend on the markets you wish to track. If you want to track the UK stock market then you would need a FTSE tracker fund. Index tracker funds come in two forms usually, OEICS/unit trusts and exchange traded funds (ETFs). Unit trusts trade daily and are usually more expensive (up to 1% annual charge) than ETFs. ETFs are traded like shares and can be invested in for as little as 0.2% of the money invested each year. ETF's low cost and ease of trading mean they are usually the best long term ISA funds or pension funds. Whichever index tracker fund (such as unit trust) or ETF you pick you usually hold then within a Stocks and Shares ISA or pension. However, each ISA and pension provider won't offer every index tracker fund so you need to ensure which index tracker funds and ETFs are available to you. Below I run through some of the best index tracker funds but the list is by no means exhaustive. But first I will run through how to build a multi-asset tracker portfolio
Build your own cheap multi-asset tracker portfolio
To build a multi-asset tracker portfolio the aim is to invest in the cheapest tracker funds and ETFs across a range of markets. Always look for cheap tracker funds with small ongoing charges and low tracking errors. On a fund factsheet the OCF is an indication of the ongoing charge and if you invest via a fund platform you shouldn't have to pay any upfront charge to invest. Check a fund's tracking error statistic (again found on the fund's factsheet) and compare it to its peers. The lower the tracking error the better as it means that the fund is actually tracking its designated index closely.
The biggest hurdle for most investors is knowing where to invest their money (i.e. the asset allocation). How much should you invest in UK equities for example? To solve this problem this asset allocation calculator will suggest an example asset mix based upon your age and attitude to risk. It takes seconds to use and will suggest how you might want to split your investments.
So based on my age and attitude the tool suggested the following example portfolio (note: it is not advice)
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- UK Gilts 6%
- UK Equities 15%
- UK Index-Linked 3%
- European Equities 8%
- Japanese Equities 4%
- Asia Pacific Equities 2%
- Global Fixed Interest 26%
- North American Equities 28%
- American Emerging Equities 0%
- European Emerging Equities 0%
- UK Corporate Fixed Interest 3%
- Asia Pacific Emerging Equities 0%
- Global Emerging Market Equities 4%
In each instance I would source the best tracker fund that invests in the stated asset. For example, if you want a FTSE 100 tracker fund then go for Legal & General UK 100 Index with an ongoing charge of just 0.1%, which is even cheaper if you buy through Hargreaves Lansdown*.
Alternatively you can buy the iShares FTSE 100 UCITS ETF with an OCF of just 0.07%. If you want bond exposure then pick a tracker with a diverse range of holdings such as Vanguard Global Bond Index. Which you can pick up for 0.15% OCF. It invests in government and corporate debt around the world with exposure to the US, Europe, UK and Japan
Index trackers funds lend themselves to building portfolio such as the “permanent portfolio”, advocated by the famous American investor Harry Browne. which invests 25% in gold, 25% in cash, 25% in US Treasuries (America's version of gilts) and 25% in US equities. It’s a true 'buy and hold' portfolio and not a bad starting point for the novice investor. You could build the equivalent with the trackers above and use a gold ETF tracker such as ETFS Metal Securities Ltd Physical Gold. When investing via ETFs I prefer to use those that physically hold the asset (physical ETFs) as opposed to synthetic or sampled ETFs as it reduces the tracking error and counterparty risks.
Ultimately you should end up with a portfolio containing a range of FTSE tracker funds, Global tracker funds, US tracker funds, European trackers, Emerging market trackers (which tend to be more expensive as they are more esoteric so expect to pay nearer a 1% annual charge) and Japanese tracker funds. One of the best sites for finding ETFs and tracker funds is trustnet which allows you to screen passive funds by where they invest, how much they cost, performance and even the tracking error.
Best Multi –Asset tracker funds
If you are still keen to find a 'buy and hold' a tracker fund for the long term (that invests in more than one asset) then you need one that will weather the market sell-offs as well as provide upside potential.
The standout fund for those wanting upside potential while limiting the downside is Vanguard - LifeStrategy 20% Equity. The fund is passively run (and is a unit trust) and packed full of index trackers with around 20% exposure to equities with the rest in fixed interest. The fund benefits from being globally diversified as well.
The fund has shown an incredible lack of volatility and consistency of return during unpredictable market conditions. For example during August 2015's market rout, which saw the FTSE 100 tumble over 12%, the Vanguard fund barely fell 2%
But it’s not just all about avoiding the dips as the fund also performs well in rising markets. In the last 3 years the fund made 21.24% easily outperforming the average Mixed 0-35% Shares fund (14.53%) and almost matching the FTSE 100 (which is up 22%). Being a passive fund it is also incredibly cheap with an ongoing charge of just 0.24%. The fund invests in a range of assets including Global and UK Fixed Interest as well as equities in the UK, US, Japan and Europe.
If you want to take on a bit more risk then go for the Vanguard LifeStrategy 40% Equity. They also do 60%, 80% and 100% versions.
Best smart tracker funds
Being passive doesn’t have to mean that you simply accept whatever the market, which you choose at outset, gives you. You can get ‘smart trackers’ which add a layer of complexity to their tracking and therefore another layer of cost. The key to successful investing is to buy low and sell high, but traditional index tracker funds tend to do the opposite with their weightings determined by the index they track. Therefore if shares of a company rally they end up making up a bigger percentage of the index and therefore of the corresponding trackers.
The Invesco Powershares’ FTSE RAFI UK 100 ETF tracks the FTSE but attempts to outperform it buy using value metrics to decide on the index weighting. So it's more aligned with the 'buy low, sell high' investment ethos.
Also Ossiam have teamed up with Barclays and Robert Shiller (the economist made famous by his CAPE value measure) to offer ETFs that invest in sectors of the market offering the greatest 'value' and strong price momentum. Think of it as an ETF that adds a dash of value and momentum investing to its selection process. At the moment you can gain exposure to European equities via Ossiam Shiller Barclays Cape Europe Sector Value ETF. Most smart tracking ETFs aren't worth bothering with but this one has real potential.
Best cheap tracker ISA fund portfolio
If you simply want to benefit from the cost savings associated with running your own tracker portfolio but don't want to worry about asset allocation then Moneyfarm* offers a selection of portfolios where they manage the underlying investment selection for you using low cost ETFs. In fact, so confident are they in their service that they will run up to the first £20,000 of investors' money for free for the first year (via the link above). They mainly use ETFs that track indices so that they can keep the overall price down and charge no more than 0.7% to manage your money. Think of it like an active tracker portfolio which is managed for you for barely any additional cost.
Best cheap tracker pension fund
Unfortunately, Moneyfarm does not yet offer a pension but Nutmeg offers a pension product with readymade tracker portfolios. The portfolios are diversified across assets and geography and use ETFs to track market indices. Nutmeg provides a choice of 10 managed portfolios each with a different mix of investment assets.
If a link has an * beside it this means that it is an affiliated link. If you go via the link, Money to the Masses may receive a small fee which helps keep Money to the Masses free to use. The following link can be used if you do not wish to help Money to the Masses or take advantage of any exclusive offers - Hargreaves Lansdown, Moneyfarm