Beat the Index

Index Tracking

These pages are intended to demonstrate how it is perfectly possible to consistently beat the Footsie, beat the FT100, beat the Dow or any other similar main index. Yes - that's not only match the performance of a particular index, but better the index overall - net of all costs and taxes.

Market indices were invented at the end of the last century in order to get some kind of general idea of what is happening to share prices in general. Groups of shares that are a proportion of the shares that people happen to be interested in are lumped together in order to give a representation of that area of the market as a whole. On the London Stock Exchange (http://www.londonstockex.co.uk) there are a number of indices, so let's take a look at just two.

Firstly, there's the FTSE All-Share Index. This is an index comprising around 800 shares, which make up about 98% of the total value of the index. In the last 20 years, this index has performed at around 13% per year.

Then, there is the FTSE 100 Index, which comprises the 100 largest companies, making up about 80% of the total value of the index. This has brought in an annual return of about 12.5% since its inception in 1984. When you hear that the "Footsie is up," or the "Footsie is down", this generally refers to the FTSE 100.

The last twenty years have seen quite high levels of inflation. Historically, the real rate of return - meaning the total return less inflation - from the stock market has been about 8%.

Generally the FT100 is derived by multiplying each companies current share price by the number of shares they have in issue (this product is called market capitalisation). The top 100 from this list then become the FT100 constitutes (broadly speaking) and the list is reviewed on several occasions each year. Not every company within that list however will have a equal weighting upon the index. Generally the larger companies will be assigned larger weightings. There are also other criteria involved such as an existing FT100 company won’t be dropped from the index until it falls below a certain level in value. Calculating the exact indexes constitutes and current level is therefore quite difficult to make.

Some investors like to invest in such a way as to mirror (or match as close as possible) the performance of a particular index. You may already be aware that one of the base rules for successful investing is to spread your risk. That is to buy a spread of shares and not ‘put all your eggs in one basket’. Selecting 100 or so shares to follow would reasonably protect an investor against one or more selections performing badly. However for the private small investor, the costs and work involved in having such a wide range or shares is just too much to be of any real benefit. An alternative to this is therefore to ‘Buy the Market’.

Buying the market involves "buying" the index and following its fortunes through thick and thin, secure in the knowledge that over time you will outperform the majority of professional investors (Fund Managers).

There are a number of unit trusts that follow the FTSE All-Share or the FTSE 100 as closely as they can and these are known as index-tracking unit trusts. Different index trackers use different strategies to mimic the performance of the index, and the details are unimportant so long as the index is tracked reasonably closely. Mostly, however, the fund managers that manage these funds do so on a cost basis. That is they charge you for their efforts. Additionally, not all such funds accurately track the intended index (variances from the exact tracking are published as "tracking error" figures).

Relatively high returns are possible with very little effort can be made by Index tracking, as an example, over the period February 1st 1989 to February 9th 1998, the Gartmore UK Index Tracker returned 13.87% annually on average after charges. In other words, money invested over this period was actually accumulating at the rate of 13.87%, taking into account all charges and costs. This is on top of dividends being distributed. During this time the FTSE All-Share returned 14.39%. However, during the same period the average UK Growth unit trust returned a miserly 10.33% and the average UK Growth and Income unit trust returned just 10.83%. The index tracker, the "no-brain, no high overheads, mimic the market average" investment approach beat the active fund managers by over 3%!

Of course, it is important to realise that 10% will not pile onto the value of your investment smoothly year on year. Some years, there will actually be a loss, and other years a far greater gain than 10%, for that is how the market travels and in buying an index tracker the investor ties his/her fortunes intimately to the short-term ups and downs of the market.

As with any stock market investment, you shouldn’t consider investing for anything less than five years or more. If you think you might need this money in the next two years then don't put it in an index tracker and, in fact, don't put it anywhere near the stock market.

See how we run our own DIY Index Tracker (DIY IndexTracker) that not only avoid having to pay the professionals commission, but all profits are also tax free too! Best of all, if, as generally has been the case over the last century, shares (equities) continue to outperform cash based investments, this tracker will OUTPERFORM the Index - that is it will return higher returns, net of all costs, than that of the Index itself.