Investing in index funds

None of this constitutes financial advice or guidance. Just my personal take, written for myself, and I don't guarantee its accuracy. Take independent financial advice for any of your own decisions.

If you have money that you don’t need to touch for several years, you should invest it.

“But investing is risky, isn’t it? A high interest savings account at my bank gives me a guaranteed return.”

Even the highest interest savings accounts generally pay below inflation.

So yes, you’re getting a guaranteed return… but that guaranteed return is that you’re guaranteed to LOSE money in real terms year after year.

So by doing nothing (leaving the money in the bank), despite feeling like your money is growing, in real terms you’re LOSING money.

Not so safe now, right?

Investing is how to make your money grow in real terms.

“It seems hard, and risky, to know WHICH stocks to buy to make money. I could lose it all.”

I totally agree. I wouldn’t recommend putting all the money in a few companies that you think are going to do well.

Let me explain from the beginning.

There are two ways to invest in the stock market:

Active: this is the one you usually think of. It’s about buying shares in companies you think will go up in value, and then selling them, to try and turn a profit
Passive: buying ‘index funds’ which simply track the entire market. You win to the extent that the overall market of your country / the world increases, or vice versa

Passive is incredibly easy - you can do it yourself in a few clicks online, and then rarely ever think about it again.

So, for active to be worthwhile vs passive, you (or the person managing your funds for you) has to beat the average gains the market is making.

(For reference the global market has been growing an average of ~10% per year. The is what the active traders have to beat—after taking into account management fees if you’re paying someone to do it for you—to be worthwhile.)

Banks would have you believe that beating the market is easy for their experts to do—they’re experts, after all. But it turns out…

Every year 80% of experts (bank / hedge fund managers) who make active investments for themselves and/or their clients do worse than the market.¹

Only 20% manage to beat the market.

AND every year it’s a different 20%.

AND it’s impossible to know in advance who the 20% will be.

Meaning over the long term, odds are that you’ll do BETTER to invest the easy way: putting all the money in a passive index fund and forget about it.

The only exception is if you enjoy the game of trying to predict how companies will do and betting on that.

But if you want the statistically best chance of increasing your pot of money, passive index funds are the way to go.

“Surely passive can’t beat active, otherwise no-one would do active?”

You’d think so, but study after study shows that passive is the smart way to go.

Even Warren Buffett recommends that you just invest passively for best returns.²

Don’t forget, the hedge fund / bank wins regardless of whether your investments beat the market or not, because they take a percentage (e.g. 1%) of the entire amount you have invested, not just of how much better you do than the market.

So all a hedge fund manager has to do is to make it look like they’re doing enough to beat the market, and provide you sufficiently complex reports to obscure the fact that they’re not. Ask your hedge fund manager for their performance for the last 15 years, after fees, compare it to an index fund, and see for yourself.

“OK, let’s go passive. How do I do it?” (UK)

You need a few things:

a platform for holding the investments
an investment vehicle within that platform (ISA / pension / general trading account)
a decision on which passive index fund you want to invest in

Platform

For smaller amounts - Vanguard / AJ Bell are good as they charge a small percentage of your funds.

For larger amounts - Interactive Investor / iWeb are good as they charge a fixed fee regardless of amount held.

Vehicle

There’s more written about this all over the internet, but some brief notes:

ISAs have favourable tax treatment.

Pensions (SIPPs) have favourable tax treatment, with the caveat that you can only access them after a certain age.

If you’ve maxed out your ISA limit for the year and for whatever reason don’t want to contribute more to pension, you’ll have to use a general trading account which may be subject to tax on gains.

Passive index fund

HSBC FTSE All-World tracks the FTSE All-World. Approx the 3,000 biggest companies in the world (90-95%+ of the world’s market capitalisation). Fee ~0.13%
Vanguard FTSE Global All Cap tracks the FTSE Global All-Cap. Approx the 8,000 biggest companies in the world. Fee ~0.23%
Vanguard LifeStrategy is an actively managed fund of passive funds. Typically has a higher UK weighting than the world market does, which some people like and some don’t. Can also choose to have bonds mixed in (lower expected returns but less volatility) which is a very smart thing to do in a number of situations. Fee ~0.22%

Any of those are great, pick one, don’t sweat it. I currently just go HSBC FTSE All-World as I don’t reckon adding the smaller cap companies would justify the extra fees, but I wouldn’t argue someone deciding the opposite.

For reference if I were in the US and my home currency were USD I might look at something like VTSAX (Vanguard Total Stock Market Index Fund) which tracks the US market. You can do that from the UK too—using the Vanguard U.S. Equity Index Fund—but then you’re betting on the US market AND the currency conversion going your way at the same time, so I don’t do this, even though it’s historically been performing well.