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, but this involves doing lots of research and, ideally, 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. This can be anything from using tracker funds or a traditional actively-managed fund. The latter involves you and lots of other investors handing 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” – 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 stockmarket index.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
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.
What is a tracker fund?
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 copies the composition of the FTSE 100 index, with the goal of delivering the same annual return – at least, before costs are deducted.
Tracker funds may hold all (or a representative sample of) the stocks in the underlying index (“physical” replication), or replicate the performance of the index via buying derivatives (“synthetic” replication).
The first index fund that was available to ordinary investors was the First Index Investment Trust, which launched at the 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.
What are the pros and cons of tracker funds?
The big advantage of passive investing is cost: a FTSE 100 tracker fund can have an annual charge of 0.1% a year, or even less. An actively managed fund could easily charge ten times as much, with no guarantee it will beat the index (most don’t over time).
But critics of index funds often point out that investors have no control over individual stocks when buying into them. There can also be significant upside when markets are doing well – but index fund investors can be exposed to downside risks when markets are faltering.
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 have 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.
Sign up to Money Morning
Our team, led by award winning editors, is dedicated to delivering you the top news, analysis, and guides to help you manage your money, grow your investments and build wealth.
-
The top stocks in the FTSE 100
After a year of strong returns for the UK’s flagship index, which FTSE 100 stocks have posted the best performance in 2024?
By Dan McEvoy Published
-
A junior ISA could turn your child’s pocket money into thousands of pounds
Persuading your child to put their pocket money in a junior ISA might be difficult, but the pennies could quickly grow into pounds – and teach them a valuable lesson about money
By Katie Williams Published
-
What is a dividend yield?
Videos Learn what a dividend yield is and what it can tell investors about a company's plans to return profits to its investors.
By Rupert Hargreaves Published
-
High earners to pay nearly £2000 more in tax due to fiscal drag
Videos The government froze tax thresholds, which will drag employees into higher tax bands as wages rise with inflation. We explain what fiscal drag is, and how to avoid it.
By Nicole García Mérida Last updated
-
What is a deficit?
Videos When we talk about government spending and the public finances, we often hear the word ‘deficit’ being used. But what is a deficit, and why does it matter?
By MoneyWeek Published
-
Too embarrassed to ask: what is moral hazard?
Videos The term “moral hazard” comes from the insurance industry in the 18th century. But what does it mean today?
By MoneyWeek Published
-
Too embarrassed to ask: what is contagion?
Videos Most of us probably know what “contagion” is in a biological sense. But it also crops up in financial markets. Here's what it means.
By MoneyWeek Published
-
Too embarrassed to ask: what is a marginal tax rate?
Videos Your marginal tax rate is simply the tax rate you pay on each extra pound of income you earn. Here's how that works.
By MoneyWeek Published
-
Too embarrassed to ask: what is stagflation?
Videos Traditionally, economists and central bankers worry about inflation or recession. But there is one thing worse than both: stagflation. Here's what it is
By MoneyWeek Published
-
Too embarrassed to ask: what is the metaverse?
Videos The term “metaverse” sounds like something out of a science fiction novel (and it is). But what does it actually mean?
By MoneyWeek Published