Record amounts of money were invested into tracker funds in 2014, new figures from the Investment Association show.
Sales of this type of fund were up £4.7 billion, a 23.5% increase in a year.
The total amount of funds under management is now £93.2 billion, with tracker funds now making up 11.2% of the total funds under management in the UK, up from 9.8% at the end of 2013.
But what is a tracker fund and why are they such a popular investment right now?
What is a tracker fund?
Tracker funds – also known as index tracker funds or passively managed funds – are linked to the performance of a specific index, such as the FTSE 100.
They work by simply following the index rather than trying to beat it.
So if the index you pick were to rise in value by 5%, your investment would do the same after fees, charges and something called tracking error, which measures how closely a fund moves in line with its underlying index.
But if the index goes the other way and falls in value by 5%, your investment will drop by roughly the same amount plus the associated costs.
Why are tracker funds so popular?
Tracker funds offer a cheap and simple way to invest in the stock market, which makes them perfect for a first-time investor.
Instead of paying for a fund manager to select a basket of stocks and shares, you just pick an index to replicate, which can be passively managed by a computer.
As there is no active manager the fund charges are significantly lower.
Last year a raft of providers including Vanguard, Legal & General and Fidelity slashed their fees, making trackers even more attractive to investors.
How to invest in a tracker fund
The first step is to pick an index you want to track.
You may prefer to stick with a UK market like the FTSE 100 which follows the 100 biggest UK companies or the FTSE All Share which represents 98% of UK listed companies.
Alternatively you may want to try your luck with global tracker funds, which replicate indices overseas. Your decision will depend in part on your attitude to risk and your feelings about the markets or sectors you want to track.
The Investing In Funds website can help you to research past performance. However, you should bear in mind past performance is no guarantee of future returns.
Tracking error is another important element to consider. This measures how closely a fund moves in line with its underlying index.
This might sound odd when funds from different providers track the same index, but different funds can have different strategies. Some funds buy all the companies in the underlying index while others buy a selection.
Low tracking error means a portfolio is closely following its benchmark. High tracking errors indicates the opposite.
Once you’ve chosen the index you’ll need to compare charges. The best way to do this is to look at the ongoing charges figure (OCF).
These tend to come with platform charges, and there may also be other charges like annual management fees and exit fees to consider, but these should be clearly set out so you can make a decent comparison.
The cheapest tracker funds
The cheapest fund tracking the FTSE 100 is the Legal & General UK 100, which has an ongoing charge of 0.10%. But if you buy through Hargreaves Lansdown that falls to 0.06%.
Meanwhile the cheapest fund tracking the FTSE All-Share Index is the Fidelity Index UK Fund, which has ongoing charges of just 0.07% when you buy through Fidelity or just 0.05% when bought through Cavendish Online.