This piece first appeared in Reader's Digest in May 2000
The text here may not be identical to the published text
If you had invested £1 in a typical range of shares in 1900 by the end of the century it would have been worth £16,946. That is an average return of 10.2% every year for 100 years despite one major stock market crash and two world wars. Even after the ravages of inflation, which has reduced money to a fiftieth of its value 100 years ago, the real rise in share prices has been an average of 5.9% each and every year of the 20th century. Put another way, the equivalent of £1000 invested in 1900 would be worth £325,000 today. Nothing else has performed as well.
These startling calculations by the investment bank ABN Amro show us the best way to invest our money for the long-term. Ignore the arguments about high technology stocks or traditional ‘blue chip’ companies. Stay out of the discussion about growth in different parts of the world. Disregard concerns about whether the market is about to fall. Just hitch your wagon to the reliable old workhorse – the whole stock market. And watch it climb steadily year after year after year.
The way to do that is to invest your money into a fund which ‘tracks’ or follows the stock market. The way to do that is to link up with one of the indexes published by FTSE international which work out how the stock market is moving. The ‘All Share Index’ uses the share price of all the shares which are big enough to trade in, around 800 (there are another 1200 it ignores). Perhaps the best known is the FTSE 100, the index of shares in our biggest hundred companies. There is also a FTSE 250 which measures the next biggest 250 companies. Which of the three you choose to hitch your star to, is up to you. In the long-term I think bigger companies are a safer bet. After all the market determines which are the biggest hundred. As share prices rise and fall, the members of this elite club change. Over the last ten years the FTSE 100 index has grown more than the FTSE 250 or the All Share index. On the other hand, many experts say that in the very long-term the All Share must represent the surest and steadiest growth.
Just as important as choosing an index, is deciding which of the many tracker funds on offer to trust your money to. You might think that as they just track the market they would all perform the same. But two things affect the growth of your money. First, charges. Although tracking the market is an automatic process left largely to computers, tracker funds still charge you for the service they offer. There is an annual charge ranging from 0.25% of your investment to as much as 1.15%. A few also make a one-off charge when you first invest – as high as 5.5% in one case though that is exceptional and most have scrapped this upfront fee. Even with a small charge eating away at growth each year, your money has to work very hard to keep up with the index. One thing helps pay for all this work. Most shares attract dividends – a share of the profits each year which is divided up among shareholders. In a tracker fund these dividends are re-invested. Nevertheless, most trackers fail to grow quite as fast as the index itself.
The second thing which makes one tracker better than another is how accurately the job is done. Each company on the stock market has a value, known as market capitalization. That is simply the number of shares multiplied by the share price. To track the index, the fund buys shares in proportion to the value of each company. For example, British Sky Broadcasting, the 11th biggest company, is worth about £2.8 billion. The total value of the FTSE 100 companies is about £1350 billion. So BSkyB represents 2.8/1350 or around 2% of the total value. For every £1000 invested in a FTSE 100 tracker, £20 is used to buy shares in BSkyB. But Boots is much smaller, so only £3.10 will be used to buy Boots shares.
As the value of companies changes, the proportion of shares in each company has to change too. It is how accurately this process is carried that determines how well a fund ‘tracks’ the index. Remember that each time a share is bought and sold, commission is charged. So funds have to decide how often they change their share portfolio. Many smaller funds do not bother to track the index precisely – they use approximations to get close to the total market.
There is another, more recent problem with tracker funds – a lot of your eggs are in a very few baskets. The FTSE 100 is dominated by a few big companies. Recent mergers mean that one company, Vodafone Airtouch, accounts for about 15% of the value of all the biggest 100 companies. A third of your money will be in the top four – the telecoms companies Vodafone and BT, oil giant BP Amoco and High Street bank HSBC. A half of your money will be in the top ten. So a tracker fund does not spread your money around as much as you might imagine. And there is another, legal problem. No investment fund can put more than 10% of its money into the shares of one company. So, unless the law changes, a FTSE 100 tracker will be limited to investing only 10% of the fund in Vodafone Airtouch and will have to decide how to spread the other 5% around to balance the investment.
One question remains: why put money into a tracker when funds which are actively managed by skilled experts do better? After all, not one of the top 20 investment funds over the last five years was a tracker fund. The problem is, past performance is not a guide to the future and picking the fund that will do well over the next five years is, literally, impossible. However, tracker funds have beaten three-quarters of the funds that are actively managed over the last five years, and it is likely they will do so over the next five as well. In the very long-term, it is unlikely that any managed fund will beat the index – and even if a small number do, picking them in advance is as impossible a task as picking shares. All the research shows that even when the market is falling, actively managed funds are no better than trackers.
TRACKER FUNDS CHOICE
Scottish Widows UK All Share – upfront charge 0% - annual charge 0.25%
M&G Index tracker – upfront charge 0% - annual charge 0.3%
Best performing (so far):
£1000 invested over period up to 21 January 2000.
Best over 1 year – Dresdner RCM UK Index All Share - £1159.07
Best over 3 years –Footsie Fund FTSE 100 - £1584.29
Best over 5 years – HSBC Footsie Fund FTSE 100 - £2257.60
Source: Reuters Hindsight
The Chase de Vere Performance Guide. For a free copy of this guide to every investment fund in the UK ring 0845 609 2003.
The Millennium Book – A century of investment returns - ABN Amro 020 7678 8000