Our Pick Of The Best S&P 500 Index Tracking Funds

If you were to put money into an index tracker, the cash is used to invest in all the companies that make up a particular index. This provides would-be investors with a more diverse portfolio compared with buying, say, just a handful of stocks.

Index trackers aim to mirror a specific index as closely as possible, and they do this in one of two ways.

The first method is by a process known as ‘full replication’, which essentially means buying all the components of a particular index. For example, in the case of an S&P 500 tracker, the fund will buy shares in all 500 companies within the index in proportion to the size of each company as it appears within the index.

The second process is called ‘partial replication’. Rather than just buy all the shares in an index, trackers in this camp invest in a representative sample of companies that feature on a particular index.

Index trackers can be bought direct from fund providers and also be arranged through both professional financial advisors and robo-advisor investment services. But it’s typically more usual to gain exposure by buying tracking funds that are available via online investing platforms and investment trading apps.

One way to weigh up the performance of a passive investment fund is to consider its tracking error. This reflects how much a tracker fund’s performance deviates from the index or any other benchmark that it’s meant to be copying.

Tracking error is measured as a percentage, so a tracking error of 0% indicates perfect replication. A tracking error that is just the cost of the fund (see below) would reflect a passive investment that is doing its job exactly as it should.

Because of the way they function, with a greater emphasis on computing power, passive funds tend to be cheaper than their actively managed counterparts.

The reason for this is because, regardless of whether an index tracker relies on full or partial replication, the fund ought to cost less to administer overall than it would if it employed a team of active managers.

The three tracker funds identified above each have an ongoing fund charge (OCF) of 0.06%. The OCF reflects the fund’s running costs as set out by the fund provider.

A £1,000 investment in our funds in the spotlight would therefore cost £0.60p although, depending on where the fund was bought, additional administrative/dealing charges may also apply. In contrast, the OCF for an actively managed fund might typically fall in the range between 0.5% and 1%.

Any kind of stock market-based investing incorporates a risk of some kind. That said, an index tracker fund that owns dozens, if not hundreds, of shares is better diversified than a portfolio that holds just a handful of companies, therefore typically lower risk.

For an S&P 500 tracker to effectively become worthless, each component company would technically have to fail before investors lost everything. That said, depending on its focus, an index could underperform and lose money for several years if, say, a sector or investment region fell out of favour.

The S&P 500 Index of large, US listed companies is the world’s most replicated investment benchmark.

According to Bestinvest’s Jason Hollands, it is also “one that is notoriously difficult for active fund managers to beat on a consistent basis”. A challenge adds Mr Hollands “that has become steadily tougher as the index has become increasingly concentrated around a handful of mega-cap technology and online stocks that have accounted for the majority of its returns over the last decade”.

S&P 500 index tracker funds have become the default choice of many investors when it comes to investing in US equities. Even Warren Buffet, the world’s most famous investor, is a fan of the approach.

The good news is that the costs of S&P 500 index funds have become cheaper in recent years thanks to a price war between providers and a fraction of the fees on an actively managed fund as providers slug it out for market share.

Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

As mentioned above, index trackers form part of a stable of investment funds collectively referred to as ‘passives’. Another member of the passive family is the increasingly popular exchange-traded fund, or ETF.

Similarities exist between index trackers and ETFs, but there are differences as well. Read more here about our pick of the best S&P 500 ETFs.