Starting out with investments

Foreword: I’m new to investing so much of what I write may be incorrect or misguided. Please don’t take anything I say as financial advice.

For a while now I’ve been aware of the whole area of investments – shares, indexes, trackers, funds, corporate bonds, gilts, etc – but I haven’t yet dipped my toes in. After looking through the Foolish guide (a little dated, but still a good source of information) that’d been lurking on my shelf for a while I decided it was time to take the plunge.

Why now, given the current economic state? Well, that’s exactly why. Share prices are currently looking pretty attractive compared to where they were a year or so ago. Will things fall further? Possibly, but it’s quite likely (given past trends) that we will eventually pull out of this dip, and I’d like to be there to take advantage of that.

But, the main reason I guess is my age. I’m now 30, which means I’m not far off halfway to retirement! My wife and I both have pension schemes with our jobs, but it seems sensible to put away something extra. So I’m looking at the long term – we’re talking 30+ years. If I invest a regular sum every month for the whole period it should build up nicely by the time we retire, and we’ll be able to take advantage of pound cost averaging.

In this current climate I believe the most important investment to have is cash. Things are uncertain, so a buffer of a good few months salary is well worth having. We’ve been saving in to cash ISAs for a couple of years, so we’re OK on that front.

To start out my investment portfolio I’ve decided that an index linked fund will be best. It’ll make a good core holding, and I can add other holdings if I have some spare funds in future years. I’ll make a regular monthly payment and reinvest any returns (a Fool loves compound interest!). The FTSE All-Share index covers a broad range of the UK market, so something based around that seems like a safe choice.

The next question was whether to go with a passive fund (such as an OEIC – Open Ended Investment Company) or with an ETF (Exchange Traded Fund). There isn’t an ETF for the FTSE All-Share, but you can get something similar by combining the FTSE 100 and FTSE 250 funds. So the important factor becomes the cost, and for that we need to look at the TER (Total Expense Ratio) for each fund.

First I looked at the Legal & General UK Index Trust tracker fund. It has a TER of 0.52% which includes an AMC (Annual Management Charge) of 0.50%. Then I looked at the Fidelity MoneyBuilder UK Index tracker fund which has a TER of 0.30% including an AMC of just 0.10% – they claim to be the cheapest UK tracker fund on the market.

Next on to the iShares FTSE 100 ETF. That has a TER of 0.40%, of which 0.35% is an AMC. The iShares FTSE 250 ETF also has a TER of 0.40%. So not much to choose between them? Lets look at the other charges involved.

It turns out that it’s usually free to pay money in to a fund on a regular basis (and probably for lump sum payments, although I’ve not checked). However, the same can’t be said for ETFs. The clue is in the name – Exchange Traded Funds. This means that these funds are purchased on the stock exchange just like you’d buy a share in a UK company. The downside to this is the dealing charges, which can be around the £10 mark for each transaction – not a big deal for large lump sum investments, but look out regular investors!

Crikey! If you’re investing £100 a month that’s 10% of your money being used up straight away. Fortunately, it’s not quite that bad. Most dealers seem to offer a package for regular investors with a special rate of around £1.50 per trade. 1.5% is looking much better – invest more than £100 and it’s even less.

So, lets compare. When we’re talking about TERs of 0.30% to 0.52% for passive funds, 1.5% (lets assume a £100 pcm investment for now) seems quite high, right? Yes and no. For the first year it’s reasonable to do a direct comparison, but in the 2nd year you’re only paying the 1.5% charge on the money you put in during that year. So, now it’s 0.75% to add to your TER. Year on year the percentage compared to your total fund decreases to the point where it’ll eventually become insignificant.

Another thing to consider is dividends. The passive funds usually have an option to automatically reinvest dividends, which is a good thing for the long term investor. The iShares ETFs currently don’t, so you’ll have to reinvest manually. Not a deal breaker, but worth noting.

My conclusion is that they’re approximately equal for an investor (please remember my foreword!). Which did I decide to go for in the end? I’m still deciding, but I suspect I’ll be opening up a Fidelity account and investing in their MoneyBuilder UK Index fund in time to get it in to this year’s ISA.

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6 thoughts on “Starting out with investments

  1. Well done on your timing Tim, albeit it by luck (or isn’t it always? 😉 )

    I think you made the right choice starting with an index fund, especially considering dividend reinvestment. ETFs become more useful when you have a broad, more widely allocated portfolio (i.e. between different asset classes) as the ease of trading helps with rebalancing.

    If I might be permitted to link to one of my own articles on the subject, you and your readers might find this article on ETF portfolios for UK investors interesting:

    http://monevator.com/2009/10/26/lazy-uk-etf-portfolios/

    best
    M.

  2. Hi Chris,

    Regarding the S&S ISA, I definately think it’s a good idea. Unless you’ve got some other use for the allowance it’s good to make use of it whilst you can. As you say, down the road it may save you from capital gains tax. One other thing I have been thinking about is a SIPP, but the money is definately locked away then, and I’m not sure I understand them enough to make a decision on it yet.

    I did go with a tracker fund in the end, and I luckily put my first sum in at the current bottom of the market (by pure chance!). I’m under no illusions that it won’t be a rough ride from here, but the past couple of months have started to look more positive. However, over the long term who knows what’ll happen 🙂

    Thanks for the recommendation on A Random Walk Down Wall Street, I think it’s on my list already.

    Something I’ve found useful lately is listening to podcasts. I have some slots in my day when I’m doing other things but my brain is idle, so I use that time to educate myself. Generally I just listen to news style podcasts like the money ones from Radio 4 and 5, but I also find the Motley Fool ones interesting. I don’t think they’re always directly applicable, but I don’t pick up a lot about the general state of the economy.

    Good luck with your investing.

    Tim.

  3. Hi, I really enjoyed reading your article, I am very much in the same position as yourself and am in the process of selecting a tracker fund, I will suggest you to read A Random Walk Down Wall Street which outlines very well the attractiveness of the index fund versus managed funds. another thing I was considering was about whether or not to place the tracker fund into a stocks and shares ISA, what do you think about this? I think if you are investing long term you get the insurance against capital gains tax – some also have no annual management fees but its something im still researching. I also concur that whilst it is a bit scary as a first time investor like myself to invest in a time when the index is going through the floor, it makes sense when “eggs are on sale, then its time to buy eggs” im in this for the long term too.

  4. I believe in compound interest. The key to it is actually beating inflation and to start early so that you have more money by the time that you end. But, it would be hard to save without the proper guidance and there are a lot of scams circulating.

  5. As I said in the post, I’m thinking about the long term. The recession is almost certain to recover over the next few years, and definitely over the next 30 years (although maybe we’ll have another by then!). So buying in to something when it’s cheap is a good thing.

    For short term gains I’d certainly agree that it’s not the safest thing to do.

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