If you have an index tracker, you are almost always best to tuck it into an individual savings account, or ISA. This is because once your tracker is safely wrapped within an ISA, any gains it makes will be tax-free.
So what’s an index, anyway?
An index is a measure of how well the stock market is performing. It allows investors to tell how well their shares are doing by comparing them to the market as a whole. If the shares you hold are outperforming the market, you are doing better than the index… and the same logic holds if your shares are underperforming.
Any given index consists of a number of companies, and the level of that index is is based on a calculation of the average share prices of all the companies therein. If every company in X index has a good day and thus every share price rises, you can bet the X index will go up a fair few points… and the opposite holds true on a bad day.
The FTSE 100 and other indices
The FTSE 100 is referred to as “the Footsie”. It is composed of the 100 largest companies listed in the UK. Other popular UK indices include:
- FTSE Allshare: the largest 700 or so companies.
- FTSE techMark 100: the largest 100 technology-based companies.
- FTSE 250: the 101st to 350th largest companies (often referred to as the mid caps).
- FTSE 350: the 1st to the 350th largest companies.
The main US indices are the S&P 500, the Dow Jones Industrial Average (the Dow), and the Nasdaq (where most technology shares are listed). You may also hear of the Hang Seng (Hong Kong), the CAC 40 (France), the Dax (Germany) and the Nikkei (Japan).
How an index measures value
Although the value of the companies in an index is measured in pounds or dollars or Yen (and so forth), the rises and falls of indices are measured in points (most indices start off at a round number -- the FTSE 100 started at 1,000). Here’s how this works: the daily price of a company is determined by the buying and selling of shares that day. So when, say, the Tuesday prices of all the companies in an index are calculated and found to tot up to being 2% higher than the Monday price, that is reflected in the index: it rises 2%. If that index was as 5000 on the Monday, it will then be at 5100 on the Tuesday.
Most indices have a weighting system that gives larger companies more sway. This means the movements of, say, BP (LSE: BP.) and GlaxoSmithKline (LSE: GSK) would have a more significant effect on the movements of the FTSE 100 than would any of the smaller companies.
Another thing to note: dividends make up a significant element on the returns generated by shares, but as indices track the capital value of each share, most don’t include dividends. If you want an index that includes dividends, look for a Total Return Index.
So that’s the index part covered… what’s a tracker?
A tracker fund owns the same shares (and in the same amounts) as the index it tracks, and thus tries to mirror the performance of that index. An index tracker is different from a managed fund because the person who manages the index tracker is a passive investor. They simply follow the index -- they don’t have any input into which shares the fund owns.
On the plus side, this makes index trackers much cheaper to manage – so the fees attached to index trackers are usually lower than the fees attached to managed funds.
And finally, do the shares in an index tracker earn dividends? Any expenses the fund incurs will be subtracted, and the remainder will be paid out as income.
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