Today we’re going to look at purchasing an index tracker fund.
Next stop, the world – muhaha!
[Editor’s note: I think he meant to write ‘Next step, a globally diversified passive portfolio’. Or at least I hope he did.]
What is an index tracker fund?
An index tracker fund is typically an Open Ended Investment Company (OEIC).
In normal-person speak, this means a tracker fund is set-up as a company that you can buy and sell shares of. Index trackers are ‘open-ended’ because the number of shares in the company will rise and fall when investors buy or sell them from the manager of the fund.1
Some tracker funds are still set up as Unit Trusts. This means they are structured as a trust rather than a company, and investors buy and sell units in the trust. Like OEICs these are also ‘open-ended’.
From an everyday investor’s point of view, the two flavours mostly amount to the same thing. We’ll focus on OEICs, which we’ll refer to simply as index funds from here.
Before you buy anything it’s important to know how the market works.
Index funds are priced based on the value of their assets using a set formula. Unlike ETFs or shares, there is only once price for an index fund for all buyers and sellers.
This price is calculated once a day, at a set time (called the valuation point).
Index funds are typically traded at the end of the day (called the market close). To trade on a given day, you need to do it before a particular cut-off time.
If you place your order after the cut-off, your trade will go through at the next valuation point.
I’ll trade yer!
First we need to locate the fund we want to trade. We find it by searching for its fund code – a unique letter string given to every fund, which you’ll find on its factsheet – or else we can search by fund manager.
Below we’ve typed in ‘VVFUSI’, which is the code for one of Vanguard’s FTSE All Share trackers:
Here we can see there’s no ‘active’ price for fund. Instead, we’re given the last closing price (as at 1/10/2018).
We’re then taken through to the following confirmation screen:
You’ll notice we’re only confirming a total order value for our trade – £1,000 in this example – and no price. As discussed above, an index fund is only priced once a day. We won’t know the exact price we paid until the deal is done.
Because OEICs have a single price there’s no bid-ask spread, unlike with ETFs. Transaction charges are ‘hidden’ within the price. (Unit Trusts do have two prices, like ETFs.)
Aside for geeks: Most index funds use what’s called ‘swing pricing’, where the asset value of the fund is adjusted based on the volume of buyers and sellers to cover transaction charges. Historically, Vanguard used something called a Dilution Levy, which was an upfront transparent charge. This was used to cover trading costs, so that long-term investors weren’t charged for short-term trading. It was terribly misunderstood and Vanguard gave in to pressure and moved to swing pricing.
Most good brokers don’t charge a commission for trading index funds, or they charge a lower commission. This usually makes them cheaper to invest in than ETFs, where dealing fees are typically applied. No fees is a nice benefit for long-term investors looking to keep costs low, especially when you’re starting with small sums. Have a look at the super-duper Monevator Broker Comparison Table to compare charges.
When we’re happy with our order we click the appropriate boxes and send it through. After that it’s just a matter of sitting back and waiting for it to be fulfilled. The buying is done.
As with our ETF purchase in the previous article, we have to wait a while for official settlement of our trade2 but in practice you’re now invested in the fund. Your broker should supply you with a contract note for your records.
Buying and selling index funds is easier than trading ETFs, if only because you don’t have the pressure of a countdown and there’s no need to worry about spreads.
True, you do have to wait to know the exact price you pay with index funds, unlike ETFs.
But for long-term passive investors putting money into broad index funds, that’s no great disadvantage. Price fluctuations on a day-to-day basis are essentially random. We’re growing our investments for decades.
Inspired? If you’re after ideas about what index tracker funds to buy, check out The Accumulator’s overview of low cost index trackers.
- In contrast, an investment trust is ‘closed-ended’, and has a fixed number of shares that you trade on a stock exchange.
- Usually T+2. See our article on trading ETFs for more details.