The best low cost index funds for 2022

Index funds (also known as passive funds or trackers) represent a low-cost, easy way for investors to invest in a sector or asset class. Index funds simply aim to replicate the performance of a certain index, such as the S&P 500 or the FTSE 100, as opposed to actively-managed funds, which are run by managers who try to pick and choose stocks in order to beat an underlying index.

The first index fund that was available to ordinary investors was the First Index Investment Trust, which launched at the very end of 1975 (it’s still going, but now it’s called the Vanguard 500 Index Fund). It was launched by Jack Bogle, the late founder of Vanguard, who is often described as the ”father of index investing”. At the time, critics of the fund warned that it would prove unpopular as “average” performance was unlikely to entice investors.

Yet almost four decades later, tracker funds have given the active investment industry a serious run for its money. Why? Because history demonstrates that active managers frequently fail to beat their benchmarks and charge far higher fees than tracker funds.

So while active funds can still make sense in certain circumstances (particularly investment trusts), it’s easy to see why index funds have taken so much market share from their active peers over the last few decades, particularly in the most mainstream markets.

What makes a good low-cost index fund?

So what should you look out for when choosing a low-cost index fund? There are several factors to be aware of.

Tracking error: low costs are key, of course. But it’s also important to consider the tracking error (the difference between the performance of the index and the fund). Since the goal of the tracker is to match the performance, significant outperformance is just as much of a reason to worry as is significant underperformance, as it suggests problems with the way the fund is run.

Costs: every penny you pay in management fees is a penny that doesn’t compound over time. So investors should look for tracker funds with the lowest possible total expense ratios (TERs) – the annual running costs for the fund.

Listed or unlisted? Tracker funds typically come in one of two main types: open-ended funds (OEICs), which aren’t traded on the stockmarket, or exchange-traded funds (ETFs), which are. The most suitable option for you is likely to depend mostly on how your broker’s charges for owning and investing in ETFs compare to its fees for holding open-ended funds.

Here are some index funds (in no particular order) that you might want to consider if you plan on investing in US stocks or UK stocks in 2022.

Two of the best low-cost tracker funds for the S&P 500

iShares Core S&P 500 UCITS ETF

(LSE: GSPX)

Run by Blackrock, the world’s biggest asset manager, the iShares Core S&P 500 ETF is one of the largest ETFs which tracks the S&P 500 index. The expense ratio for the fund is 0.1%.

Vanguard S&P 500 UCITS ETF

(LSE: VUSA)

The Vanguard S&P 500 UCITS ETF invests in stocks in the S&P 500 index. The ETF first started trading in 2010, and is another of the largest on the market. The fund has an expense ratio of 0.07%.

Four of the best low-cost index funds tracking UK stocks

iShares Core FTSE 100 UCITS ETF

(LSE: ISF)

The iShares Core FTSE 100 UCITS ETF offers very cheap exposure to the UK’s blue-chip index, and pays out dividends, enabling investors “to benefit from any income recovery in one of the world’s highest-yielding markets,” says Investors Chronicle. The fund charges a low fee of 0.07%.

SPDR FTSE UK All Share UCITS ETF

(LSE: FTAL)

The SPDR FTSE UK All Share UCITS ETF offers exposure to the UK’s FTSE All Share index, covering around 600 companies. The fund is a bit more costly than other FTSE trackers, with a 0.2% expense ratio.

Vanguard FTSE UK All Share Index Unit Trust

For those who would prefer an open-end fund option, the Vanguard All Share tracker is an attractive alternative, with a total expense ratio of 0.06%.

Vanguard FTSE 250 UCITS ETF

(LSE: VMID)

For mid-cap investors, the Vanguard FTSE 250 UCITS ETF seeks to track the performance of the FTSE 250 by investing in all constituents of the index in the same proportion as the index. It has a total expense ratio of 0.10%.