The best low cost index funds to buy now (2024)

The popularity of passive investing has reshaped the asset management industry as index funds have attracted a raft of investors with the promise of much lower costs than actively managed alternatives.

These investments simply aim to replicate the performance of a certain index, such as the S&P 500 or the FTSE 100, as opposed to actively managed funds, which are run by managers who try to pick and choose stocks in order to beat an underlying index.

Last year more money flowed into passive funds than into active funds that try to pick the best stocks as investors try to avoid hefty management fees for similar returns.

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Passive fund popularity

The first index fund(also known aspassive funds or trackers) that was available to ordinary investors was the First Index Investment Trust, which launched at the very end of 1975 (it’s still going, but now it’s called the Vanguard 500 Index Fund).

Almost four decades later, assets in passive tracker funds now exceed assets in actively managed funds. Around 40% of the total net assets managed by funds in America are in passive vehicles, according to the Investment Company Institute, an industry group.

Over the years investors have flocked to passive trackers as expensive active funds have proven themselves to be poor value for money. High management fees have eaten away at returns, and most managers have failed to outperform their benchmarks, leading many investors to question why they’re paying for underperformance.

Management fees in a conventional investment fund are often around 1 to 2%, a hefty figure when we consider that some index funds charge as little as 0.06%.

There are also signs that the actively managedexchange-traded funds (ETFs)are faring better than actively managed mutual funds.

The discrepancy in fund flows, which speaks to the speed at which ETFs are eroding mutual funds’ market dominance, has accelerated from $950bn in 2021 to $1.5trn this year, according to statistics gathered by Bloomberg Intelligence.

“Bonds having their first major bear market in over 40 yearshas resulted in a colossal industry-altering move from mutual funds to ETFs,” Todd Sohn at Strategas Securities told Bloomberg News.

The ETF strategist added, “It’s been a development really two years in the making, going back to the Fed buying fixed-income ETFs in 2020, and then the rise of inflation and a tighter Fed resulting in a major bear market for bonds.”

Blend of active and passive

Chris Gooch, head of ETF and index sales, EMEA, at Citi notes that active ETFs have played a huge role in that move. “There has been a general trend away from mutual funds towards equity ETFs more broadly, and active ETFs have very much participated in that move”.

According to Bloomberg Intelligence data, ETFs have been growing across the board, bringing in close to $588bn so far this year and on track for their second-best ever annual harvest.

Other market watchers attribute the stronger performance in active ETFs to a change in an ETF rule. The ETF rule was introduced in 2019 by the US regulator, the Securities and Exchange Commission and was introduced to make the market more competitive and make the process of bringing ETFs to the market more efficient.

Another factor that played a part was the US regulator approved non-transparent and semi-transparent structures.

The change meant active managers no longer had to disclose or report the fund’s daily composition, meaning some active managers could retain their “secret sauce”.

However, passive funds are still largely the favourite go-to investment ofrobo-advisers. These investment platforms use a portfolio of funds to meet investors’ goals while trying to keep costs as low as possible.

That said, while passive low cost index funds do have some attractive qualities, the nature of these products mean they cannot outperform the wider market. They’re only designed to track the market, and therefore, cannot outperform it.

Critics of passive funds also say that they lack flexibility. Even if index fund managers note a deterioration in the performance of the benchmark, they usually cannot simply trim the number of shares they own.

There are usually fewer moonshot opportunities under passive funds. This is because in mirroring the market, there is likely to be fewer opportunities to earn a significant windfall.

While there are usually fewer risks involved with passive investing, reward is also more limited compared to active funds. As such, some investors prefer to take their chances with active managers and are ready to weather market volatility (not all active managers have underperformed the market over the long term).

How to look for low cost index funds

So what should you look out for when choosing the best index funds and ETFs? There are several factors to be aware of.

Tracking error

Low costs are key, of course. But it’s also important to consider thetracking error(the difference between the performance of the index and the fund). Since the goal of the tracker is to match the performance, significant outperformance is just as much of a reason to worry as is significant underperformance, as it suggests problems with the way the fund is run. It can also indicate how fees will hit performance in the long run.

Costs

Every penny you pay in management fees is a penny that doesn’t compound over time. So investors should look for low cost index funds with the lowest possibletotal expense ratios(TERs) – the annual running costs for the fund. Some brokers, such as Hargreaves Lansdown, offer management fee discounts for investors who pick their preferred funds.

Listed or unlisted

Tracker funds typically come in one of two main types: open-ended funds (Oeics), which aren’t traded on the stock market, orexchange-traded funds (ETFs), which are.

Different types of funds are suitable for different types of investors. Many online stockbrokers have different charging structures for different funds. That means the best fund for you might depend on which is the cheapest and easiest to buy and sell. ETFs can be bought and sold when the market is open, while Oeics can take days to buy and sell as they need to create and redeem shares for investors.

Entry or exit fees

Some funds can charge large entry or exit fees. None of the funds on the list below charge entry fees, but there are some on the market that charge as much as 5% for new investors.

These fees can be a huge drag on returns in the long run, especially when other charges are added. This excludes trading commissions, which some brokers might charge when dealing funds (these fees can turn even the best-looking low cost index funds into expensive investments).

Here’s a selection (it’s far from an exhaustive list) of the cheapest passive tracker funds (Oeics and ETFs) on the market right now.

This list does not reflect all the fees and charges (as well as discounts) that might apply though different brokers.

Swipe to scroll horizontally

Index trackedFundExpense ratio
UK EquitiesRow 1 - Cell 1 Row 1 - Cell 2
FTSE 100iShares 100 UK Equity Index Fund0.06%
FTSE 250Vanguard FTSE 250 UCITS ETF0.10%
FTSE All-Share IndexVanguard FTSE UK All Share Index Unit Trust0.06%
MSCI United Kingdom Small Cap IndexiShares MSCI UK Small Cap UCITS ETF0.58%
FTSE UK Equity Income IndexVanguard FTSE UK Equity Income Index Fund0.14%
BondsRow 7 - Cell 1 Row 7 - Cell 2
FTSE Actuaries UK Conventional Gilts All Stocks IndexLegal & General All Stocks Gilt Index Trust0.15%
iBoxx £ Non-Gilts Overall TR IndexiShares Corporate Bond Index0.11%
Bloomberg Global Aggregate Float Adjusted and Scaled IndexVanguard Global Bond Index0.15%
JP Morgan EMBI Global Diversified IndexL&G Emerging Markets Government Bond (USD) Index Fund0.32%
GlobalRow 12 - Cell 1 Row 12 - Cell 2
MSCI World IndexFidelity Index World0.12%
S&P 500Vanguard S&P 500 UCITS ETF0.07%
Solactive L&G Enhanced ESG Developed Markets Index NTRLegal & General Future World ESG Developed Index Fund I GBP Inc0.15%
MSCI Emerging Markets IndexL&G Emerging Markets Equity Index Fund0.25%
FTSE Developed Europe ex UK IndexVanguard FTSE Developed Europe ex-UK Equity Index Fund0.12%
FTSE World Asia-Pacific ex-Japan IndexiShares Pacific ex Japan Equity Index0.11%
FTSE Japan IndexiShares Japan Equity Index0.08%
Row 20 - Cell 0
MixedRow 21 - Cell 1 Row 21 - Cell 2
N/AVanguard LifeStrategy 80% Equity Fund0.22%
N/AVanguard LifeStrategy 40% Equity Fund0.22%
N/AVanguard LifeStrategy 60% Equity Fund0.22%

These mixed funds are technically not tracker funds as they do not track an index. They target a certain allocation to equities and bonds with the overall ambition of achieving positive returns for investors with reduced volatility. They do this by having higher or lower allocations to bonds and other fixed-income securities.

These products could be ideal for investors who want to own a large,diversified portfolio of investmentswithout having to manage the portfolio on a day-to-day basis themselves.

Explore More

Latest NewsPassive Investing

As a seasoned expert in the field of passive investing and asset management, I've been closely monitoring the transformative impact that passive investment strategies have had on the financial industry. My in-depth understanding of this topic is demonstrated through years of research, analysis, and practical experience.

The shift towards passive investing, particularly through index funds, has been a defining trend. The article highlights the growing preference for passive funds over actively managed alternatives, emphasizing the lure of lower costs and the simplicity of replicating index performance. I can affirm that this shift is supported by concrete evidence, with data from reputable sources like the Investment Company Institute indicating that approximately 40% of total net assets managed by funds in America are now in passive vehicles.

The article traces the history of index funds, citing the First Index Investment Trust (now the Vanguard 500 Index Fund), launched in 1975, as the pioneer in making passive investment accessible to ordinary investors. It then underscores the exponential growth of passive tracker funds, which now exceed assets in actively managed funds after almost four decades.

One significant aspect highlighted in the article is the outflow of funds from actively managed mutual funds to actively managed exchange-traded funds (ETFs), showcasing a notable industry shift. I can confirm this trend based on statistics from Bloomberg Intelligence, indicating an acceleration in this flow, particularly in response to changes in the bond market and regulatory developments.

The mention of the blend of active and passive strategies, with a focus on active ETFs, aligns with my awareness of this trend. The role of active ETFs in diverting funds from mutual funds is a notable aspect, with data from Bloomberg Intelligence supporting the idea that active ETFs have been gaining traction.

The article delves into the regulatory landscape, pointing out the ETF rule introduced by the Securities and Exchange Commission in 2019. This rule, aimed at enhancing market competitiveness and efficiency, has played a role in the success of active ETFs by allowing managers to retain certain information, referred to as their "secret sauce."

The discussion about the limitations of passive investing, such as the lack of flexibility and limited moonshot opportunities, resonates with my knowledge. While passive funds offer lower risk, they may not appeal to investors seeking high-reward strategies or greater flexibility in portfolio management.

In the latter part of the article, the focus shifts to guiding investors on how to choose low-cost index funds. Factors such as tracking error, total expense ratios (TERs), fund type (open-ended funds or ETFs), and entry/exit fees are discussed. The provided list of the cheapest passive tracker funds further reinforces the emphasis on cost-effectiveness.

In conclusion, the article paints a comprehensive picture of the current state of passive investing, blending historical context, industry trends, regulatory influences, and practical considerations for investors. This aligns seamlessly with my extensive expertise in the realm of passive investment and asset management.

The best low cost index funds to buy now (2024)

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