Investing, combined with the meteoric rise of commission-free stockbrokers is booming especially amongst the younger generations. One strategy, backed by successful authors like Tim Hale and Lars Kroijer, not to mention great podcasters like Pete Matthew from Meaningful Money and sources like the UK Personal Finance subreddit is leading the charge. Whilst maybe not as sexy as investing in individual stocks, interest in index investing is rocketing. 🚀
What is index investing?
An index is a portion of the market that is collected into a “basket”, for example, the 100 largest companies in the UK make up the FTSE 100 index, the largest 500 American companies form the S&P 500 index.
Here’s a snippet from Investopedia:
Index investing is a passive investment strategy that attempts to generate returns similar to a broad market index. … For one thing, empirical research finds index investing tends to outperform active management over a long time frame
Now you could recreate this by just buying all of the stocks in each index, it would be pretty simple to find out who’s included and the weightings, but honestly, that’s not worth your time although I’d really admire your effort.
There’s a snag though, none of the commission-free brokers in the UK allow you to buy index funds and let it do its thing.
(There are other issues with index fund investing — but I don’t want to get bogged down with the details).
The most common method of tracking the world as a collective index would be to just buy Vanguard’s Global All Cap, a low-cost fund that aims to track the global stock market by buying companies in order of magnitude and automatically rebalancing itself should anything change. For this service, the fund will charge you 0.23% annually. Not bad eh?
It’s also not available on commission-free brokers (fml indeed).
Ok, so an ETF is a fund that seeks to replicate an index. ETF’s are usually highly liquid as they trade on the stock exchange meaning you can buy and sell whenever you need to. They’re also passively managed, usually by algorithms that automatically tweak the allocations as companies rise and fall, this means they’re super cheap to own.
In the tortoise and hare analogy, ETF’s are almost certainly the tortoise.
They aim for slow and steady increases, whilst being diversified enough so that individual company crashes can be absorbed with minimal paper losses. Unfortunately, they cannot protect you from total market crashes and recessions, there isn’t an awful lot that can.
Replicating Global All Cap — the data (as best as you can!)
In this example, I used Trading 212’s ETF offerings, but I’ve checked and Freetrade has a similar list of ETFs.
I’ve also chosen Global All Cap to try and replicate as it seems to be the most popular and highly regarded all-cap fund I can find. Digging into their holdings I estimate they are split as follows:
Pacific Excluding Japan: 8%
Emerging Markets: 10%
Now if I compare the above with what I can find on free stockbrokers current offerings you’d be using the following funds, I’ve tried to make them all accumulating where possible as all cap is an accumulating fund, but most have a distributing alternative if you wanted to go down that route:
CSP1 / iShares S&P 500 / Accumulating
This ETF aims to replicate and track the performance of the S&P 500 and should satisfy the North America portion of our desired geography. (Sorry Canada!)
VEUR / Vanguards FTSE Developed Europe / Distributing
This ETF tracks the EU’s developed economies, this covers the UK, Switzerland, Germany, Netherlands and France primarily.
CPJ1 / iShares Pacific Region Excluding Japan / Accumulating
This ETF tracks Pacific regions including Australia, New Zealand, Hong Kong and Singapore.
VJPB / Vanguards FTSE Japan / Accumulating
This ETF tracks Japans largest companies including good-sized holdings in Sony, Toyota, Mitsubishi and Nintendo.
EMIM / Emerging Markets / Accumulating
This ETF tracks markets that are considered ‘emerging’, countries include China, Taiwan, South Korea, India, Brazil, South Africa and Russia.
I’d estimate that this covers all of the mid and large caps we need, but will leave small caps underweight, so I’d consider adding:
WSML / iShares Global Small-Cap / Accumulating
This ETF tracks small companies across the globe. The top 5 countries it holds are the United States, Japan, UK, Canada (squeezed you in) and Australia.
How much extra will this cost me?
I hear you, owning 6 self-balancing ETF’s sounds like it’s going to be more expensive, but what if I told you if you copied Global All Cap this way it could save you up to 50% in fees, with the allocation above working out at just over 0.116% average annual charge.
If you invested £150 per month, over 30 years and assume an 6% annual growth rate this will save over £2000 in fees alone.
Now it’s up to you to investigate the weightings and the fees, figure out if the funds work for you, cover what you want to cover and understand your own risk tolerances / substitute gold or bonds in if that’s your bag.
What are the downsides? 🔻
There’s a couple of immediate issues:
- It’s not a perfect replication of the index, some countries are missing.
- For now, you’ll need to keep on top of the rebalancing of ETF weightings yourself, although Trading 212 have percentage-based “auto-invest” launching soon.
- Not all of these are available as fractional shares — you’ll need to badger Trading 212/Freetrade to make this happen.
- It’s worth noting that some investors believe index funds are in a bubble but could be trying to cause a run on ETFs to satisfy their own short positions.
So who could use this?
This generation of investors has been spoilt by super quick returns on most stocks and that can lead to some investors thinking they’re invincible or the next Warren Buffett — history suggests this won’t last forever.
Again, historically speaking, passive investing has beaten active investing and many active fund managers that have had great starts have struggled later on in the fund's life as they dive into more and more risky assets to try and sustain that growth. This draws parallels to the retail investor and the years ahead.
I’ve always been an advocate of having a core and satellite style strategy. Which is, tracking a major index with the majority of your money and generally stock-picking a handful of quality companies around it in an attempt to increase the return. I know, having read and consumed an awful lot of stock market info over the last ten years, that this approach is likely to be sub-optimal.
However, in a world where everything is about gamification and our smartest people are working at companies trying to get us to click on an ad, I think the greatest issue we face as a generation of investors is that we get bored and stop investing. Passive investing is mind-numbingly boring…
…but the tortoise always beats the hare in the end.
Please note: when you invest, your money is at risk! None of these views shared in this article is to be taken as investment advice. If you are seeking advice please contact a licensed financial advisor.
The value of your investment may go up as well as down and you may not get back the amount you originally invested.
So always, do your own research.