Too embarrassed to ask: what is a tracker fund?

Instead of trying to beat the market, tracker funds – also known as “passive” funds – try to track its performance. Here's what that means.

If you want to invest money in the stockmarket, there are various ways to go about it. You can buy shares in individual companies yourself, but this involves doing lots of research and having a solid grasp of how to read and analyse a set of accounts.

Investors who lack the time, knowledge, or inclination to invest in individual companies often use funds instead. With a traditional actively-managed fund, you and lots of other investors hand over your money to a fund manager or team of fund managers, who invest your money in a wide range of companies.

The goal of the active manager is usually to “beat the market” – in other words, for their fund to deliver a better return than the wider market. For example, a fund manager investing in a basket of London-listed stocks might choose shares with the aim of beating the FTSE 100, the UK’s main stock market index.

There’s just one problem: countless studies have shown that the majority of fund managers fail to beat the wider market consistently over the long run.

This is where tracker funds come in. Tracker funds – also known as “passive” funds – don’t try to beat the market. Instead, they simply try to track its performance. So a FTSE 100 tracker fund would just copy the composition of the FTSE 100 index, with the goal of delivering the same annual return – at least, before costs are deducted. That takes us to the big advantage of tracker funds or passive investing – their costs are very low.

These days you can easily find a FTSE 100 tracker that will charge annual management fees of less than a tenth of a percentage point a year. An actively-managed fund can easily charge ten times as much.

Given that actively-managed funds struggle to beat the market, and are more expensive, it’s easy to see why tracker funds and passive investing has taken off in a big way in the last decade or so.

That said, certain types of active fund have a better record than others. And there are some smart people who argue that passive investing is at risk of distorting financial markets.

For more on those topics, subscribe to MoneyWeek magazine.

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