Getting on right lines with your investment

On the investment side, collective funds are offered which follow a published benchmark or index as closely as possible. This is "passive" saving unlike funds where shares (and possibly fixed interest and other instruments) are selected by a manager.

With tracker funds, the aim is to replicate the index performance through owning all or a representative sample of the underlying benchmark.

It works well for indices such as the FTSE 100 or the DAX where there is a small number of liquid constituents.

Traditionally such funds are a low-cost entry into markets, which is ideal both for a first exposure to the stock market (such as children's savings) and for those who want a toehold geographically or by sector outside their normal investment area.

One of the largest ranges is offered by Legal & General, currently with nine funds, none with initial or exit fees. Annual management charges range from 0.40 per cent (UK Index which tracks the FTSE All Share) to one per cent (global 100, global technology, global health and pharmaceuticals).

Vanguard, a major United States provider, has a large range, as does Fidelity and HSBC. Fidelity charges only 0.1 per cent a year for its MoneyBuilder UK Index by comparison with one per cent with Virgin.

In selecting your tracker fund, consider:

n Benchmark or index to be followed, not making it too narrow, past performance and potential charges;

n Investment sums, both lump sum and monthly subscription;

n Tax-exempt facilities, such as using an Individual Savings Account (ISA);

n Tracking error (deviation from the benchmark or index).

Last year the MSCI World Index rose 18.2 per cent but was beaten by both the FTSE 100, which increased 22.1 per cent, and FTSE All Share, which jumped 29.8 per cent.

Of course, many companies on these two FTSE indices are trading internationally even though they are major players on the London stock market.

The FTSE 100 is not representative of a balanced portfolio since around 10 companies control 45 per cent of the assets.

It is really a commodities and financials fund with a dash of

utilities, consumer and telecom shares added in.

It is too sensitive to a small number of levers, notably the US currency, interest rate changes and oil prices.

Instead the FTSE 350 or All Share would give a wider spread of

potential and risk.

Deviation from the index or tracking error is usually not too significant.

Over five years, taking Legal & General, the lowest error was 0.01 per cent (US Index and Global health and pharmaceutical) and greatest was 0.24 per cent (Pacific Index), expressed on an annual basis.

Managed funds should be true stock-pickers and then the extra costs are clearly worth it but if one is acting as a veiled tracker, opt for the low-cost latter instead.

Compare results over 20 years, investing 10,200 annually (the current ISA limit) and assuming six per cent annual growth. After charges, Vanguard research shows a tracker fund would pay 31,322 but only 23,857 in an average active fund.

Some benchmarks are less easy to replicate, such as the MSCI World with over 1,800 constituents, or less liquid, such as small-cap stocks or emerging markets.

Many stockbrokers recommend another form of tracker – the Exchange Traded Fund (ETF) – for its diverse range with not only classic indices like the FTSE All Share but commodities like gold.

There is no stamp duty or initial fee to pay but dealing costs and a typical annual 0.5 per cent charge.

ETFs work efficiently in terms of the timing and tax treatment of dividends.

Trackers are also important on the borrowing side of finance. These are mortgages which track an index, usually Bank of England base rate, and have been available for over a decade.

With Bank of England rate at 0.5 per cent so low, tracker home loans are the cheapest rates available.