UK Index Funds – A Guide for expats

Back 1975 during the run up to Christmas, a nice gentleman from the US of A, going by the name of Mr Jack Bogle, released the first index fund into the world at large and investment was never the same again. That is…. if you were classed as resident! It wasn’t until some 15 years later that expats could start rejoicing.

You see, across the border in cheery old Canada some clever chaps came up with the snappily named Toronto Index Participation Shares, which to all intents and purposes was the first ever Exchange Traded Fund (ETF).

The key difference being, as the name suggests, you can trade this one on an exchange. To residents of most countries this isn’t going to be a selling point, but to expats its a game changer, because it means we can join in the fun.

Index funds are typically restricted to resident investors, whereas ETFs are typically available to everyone as long as you have an investment account.

And here’s the key, most index funds are available in ETF format. You are essentially getting the same thing if you choose one of those.

Now, just to be clear, some expatriates living in some jurisdictions may have access to some index funds, its just that many won’t.

On the other hand, unless you are living under a rock, you’ll be able to invest in an ETF from wherever you are (internet permitting).

So in summary, index funds let the average Joe invest for his future and ETFs let expat average Joes do the same thing.

I know what you are thinking. What heck is an index fund anyway? Well….

What is a market index?

It all starts with a market index. This is a collection of shares grouped to represent a section of the stock market.

The most famous example being the S&P500, which tracks the biggest 500 publicly traded companies in the US. The equivalent in the UK is the FTSE100.

You can read a lot more on this subject here if you are interested, but the key being this forms a target for our index fund.

What is an index fund?

You see, an index fund is a basket of shares that track one of these indices. They are often referred to as tracker funds or index trackers in the UK.

When you buy a share of an S&P500 index fund your money is automatically divided between the 500 S&P500 companies in the correct proportions.

Similarly, if you buy a share of a FTSE100 index fund your money will be split between the 100 FTSE100 companies in their correct proportions.

In case you are wandering what correct proportions are, they are based on how big a particular company is. As a quick example, say Shell is twice as big as HSBC, you’d have double the amount of money in Shell as you would in HSBC.

Whilst this way of doing things isn’t exactly intuitive when you first hear about it. It seems to work. In fact, it seems to beat all other ways of doing things. Its called Market Capitalization and you can read more about it here if you are interested.

Vanguard have also gone into a lot more detail on index funds here.

What is an ETF?

ETFs are a type of fund that trades on a stock exchange just like an individual share.

Importantly for us, these funds can track exactly the same indices as index funds.

In the UK ETFs aren’t quite as popular as they are in the US and Europe but they are gaining popularity all the time.

Basically, we arrived late to the party with the first one appearing in 2000. A decade after Canada and 7 years after the US. Not only that, but ours didn’t really take off until stamp duty was removed in 2007.

No doubt, pushed by Barclays, who’d been in at the start in the US helping Morgan Stanley fight against State Street. For a long time Barclays were a big provider through iShares. They had to sell them to Blackrock when they got into financial difficulty in 2009.

The important thing is they are here now.

And rightly so, because they have lots of advantages for everyone, but especially for expatriates. And whilst most of their advantages are shared with what Jack Bogle likes to call TIFs (Traditional Index Funds), the key for those of us who live overseas is that we can invest.

Incidentally, according to Barclays, the most popular ETF UK investors choose is the Vanguard S&P 500 UCITS ETF (VUSA).

Whilst, I can’t claim to know what the most popular ETF British expats choose, I can hazard a guess that its the Vanguard All World UCITS ETF.

How to choose an index fund that’s right for you

Investing using index funds couldn’t be simpler. Just follow the steps below. For most expats who don’t have access to Traditional Index Funds, simply do the same thing with index tracking ETFs, which to all intents and purposes are exactly the same thing.

1. Choose an index to follow
2. Choose an investment platform
3. Choose an index fund (or ETF) that follows your desired index
4. Add fresh money whenever you have some free
5. Sit back and watch your balance grow as compound interest works in the background building your wealth while you get on with the important things in life

It’s worth going over these in a bit more detail.

There are a wealth of investor indices to choose from.

As touched on above, the most recognised UK stock market index is the FTSE100.

Commonly termed ‘the Footsie,“ this index tracks the 100 largest public companies by market capitalisation that trade on the London Stock Exchange (LSE).

And in fact did you know the name comes from combining LSE with the Footsie’s original parent company, the Financial Times.

FT = Financial Times / SE = Stock Exchange.

Some UK investors only invest in funds that follow this one index.

I’ve also met the odd expat that only invest in this. More commonly they put some of their money in the FTSE or perhaps a more diversified UK focused fund.

The most popular UK investor indices are shown below:

• FTSE100 (100 largest UK companies listed on the London Stock Exchange which are classed as large companies)
• FTSE250 (The next biggest 250 which are classed as medium sized companies)
• FTSE350 (A combination of the above)
• FTSESmallCap Index (The next 269 companies (351 to 619) which are classed as small companies)
• FTSEAll-Share Index (All of the above combined)

I’m pretty sure all of the above are available in ETF format except for the FTSE 350.

You could get around this pretty easily by investing in a FTSE100 & 250 together in their correct proportions (according to Market Cap).

Index Fund Diversification

I’m all for a prosperous Britain, but that doesn’t mean I’m going to invest all my money in the UK. In the scheme of things the UK stock market is pretty small. In fact, so much so that a single US company, Apple, is worth more than the entire FTSE 100.

Unless you are a sophisticated investor, the more companies you divide your money among the merrier. That’s because you then have of holding the winners and it’s these that will govern your returns.

Sure, more companies equates to more rubbish, but the winners will more than make up for the losers. It’s simple mathematics really.

Whereas a company can only loose 100% of it’s value, its potential for growth is infinite. 200%, 500%, 2000% take your pick. The Amazon’s of this world more than make up for those companies that go bankrupt.

If you’d divided £10K equally between 10 companies 25 years ago and one of them was Amazon. Even if all the others went bankrupt, you’d still be a multimillionaire today.

Picking winners is nigh on impossible. As Burt Malkiel said in a Random Walk Down Wall Street.

Identifying one is like finding a needle in a haystack. I say buy the haystack

He also points out that the biggest haystack you can get your hands on is global.

Some of the biggest global indices are:

• FTSE All World
• MSCI ACWI
• FTSE Global All Cap
• MSCI World

When you invest a fund that follows a global index your money will be shared between thousands of companies.

Think about that for a moment. Essentially, when you invest in a global fund your money will be working for you 24/7. You’ll be invested with nearly everyone and even those companies you aren’t invested in will be buying things from the companies you are invested in.

For most people most of the time, a global index fund (or ETF) is all you need. You don’t need to make any decisions. You don’t need to read the financial media. You just need to add money whenever you have some available.

That said, there are those our there who want to be more hands on. And you can do that with index investing too.

There are indices that focus on certain characteristics like income or socially responsible investing. Here are a few more alternatives:

• FTSE UK Equity Income
• FTSE All-World High Dividend Yield
• FTSE ESG Index Series
• MSCI World SRI
• MSCI World High Dividend Yield

But just to be clear. Most people should probably avoid focusing their investments.

Successful active bets are notoriously hard to pull off. Just take a trip over to S&P global and check out their SPIVA research if you don’t believe me. They show that 90% of professionals underperform their indices.

In other words, unless you are confident you can beat the wider market (90% of pros can’t), you are probably better sticking with the most diversified index you can get your hands on cheaply. FTSE All World & MSCI ACWI would be good examples.

Bond index funds

Now, its not all about stocks and shares.

The consensus says most investors will be well served investing in a bond index fund to go along with their stocks. Bonds even out the ride. Bonds add safety and stability.

Everybody has different ideas about how much of your money should be invested in bonds compared to stocks. You can read more about it here if you are interested. However, these days I like the 4% rule, where you invest 4% of your money in stocks for every year you plan to invest.

Investing for 10 years, then put 40% of your money in stocks and the rest in bonds. A 20 year investment time horizon equates to 80% of your money in stocks and the remainder in bonds.

Bonds are a little complicated so its worth doing a bit of background reading. You can start here, but here’s a quick intro:

Bonds don’t go up as much as stocks, but they don’t go down as much as stocks either. The more bonds you have in your portfolio the lower your chances of panic selling during stock market crashes. That’s important because those who panic sell either end up getting back into the market at much higher prices or more likely never get back in again.

Either of which would crystallise losses, that a bit of patience would have eradicated anyway.

So worth having then but you should be aware that bonds come with three key risks. These are duration, credit and currency and it’s worth going over these three in a bit more detail.

The risks of bonds

• Duration / Interest Rate Risk – Bonds pay interest like savings accounts but usually better. The longer the duration of a bond the more interest rate it is likely to pay. However, as duration increases so does a bonds susceptibility to interest rate risks. Just know that when interest rates go up, bond prices go down and that you can minimise this risk by investing in bond index funds with lower durations.
• Credit Risk – When you invest in a bond you essentially lend some organisation money and they pay you interest for your trouble. As with anytime you lend out your hard earned cash, there is always a risk you don’t get your money back. Bonds are no different. All things being equal, the ones with the highest interest rates usually come with the most risk that you don’t get your money back. You can minimise this risk by investing in developed market government bond index funds. Think the US, UK, Germany and Japan.
• Currency Risk – Bonds come in a particular currency and as such there is always a risk of that currency devaluing against others. What you want to avoid is the currency of your bond devaluing against the currency you use. The way to avoid this is by investing in bonds denominated in the currency you use. A UK investor should usually stick to UK bonds denominated in pounds. An expat who plans on retiring in Britain might also want to choose sterling bonds (Expats who don’t know where they are going to retire might want to read this).

Here’s a few of the bigger bond indices.

I like shorts term government bonds, but many people choose intermediate or a mix of all.

Bond indices

• (Bank of America) Merrill Lynch Global Bond Index
• Bloomberg Barclays Global Aggregate Bond Index
• Citi World Broad Investment-Grade Bond Index (WorldBIG)
• Bloomberg Barclays US Treasury Index
• Barclays Inflation-Linked Euro Government Bond Index
• Citi World Government Bond Index (WGBI)
• FTSE UK Gilts Index Series
• J.P. Morgan Government Bond Index
• FTSE UK Conventional Gilts – Up To 5 Years Index

Investment platform

Once you’ve picked a suitable index, you can then move on to choosing an investment platform.

When choosing an investment platform, good support and ease of use are key qualities to look for. However, the factor likely to impact your investment returns the most is fees. There are all kinds of costs associated with investing platforms but the main ones you need to consider are account fees and commissions.

Commissions are the costs incurred when you buy or sell a share of your index fund. They can be anything from £0 to about £25. That’s a big difference!

Account fees are charges simply for having an investment account. They can come as a fixed fee anywhere between £0 to £150 or as a percentage typically between 0.0-0.45%. Again, a big difference!

I’m sure it goes without saying that the nearer you get to zero for all these fees the better. We’ve looked at a range of investment platforms here (that accept non residents) if you don’t already have one.

Choosing your fund

Once you’ve chosen your index to follow and investment platform to use all you need to do is find a fund that follows it.

If your investment platform provides access to multiple funds that invest in the index you want to follow, it usually makes sense to choose the one with the lowest Ongoing Charges Figure (OCF).

As an example, I’m a Vanguard tracker fan, but if I were to invest in a FTSE 100 tracker I’d probably go with the iShares version because it charges 0.07% vs 0.09% for Vanguard. Every penny counts!

Now, some people will argue that you need other things in your investment portfolio like commodities, income or property so I’d be remiss if I didn’t make a few comments on that.

Keep it simple

First of all, the evidence is pretty compelling that the simpler you keep things with investing, the more successful you are likely to be.

Most widely diversified index funds will contain plenty of exposure to commodities and property. If you add them in individual funds you add complexity and costs, which most of the time are going to be unwarranted.

As for income focused funds which provide you with a larger dividend, these have two major problems as far as I can see.

The first being they tend to contain older more established companies that are no longer growing. Think oil, utilities and banking for example. Whilst this type of company does tend to pay out a higher dividend, they don’t have as much growth potential as other companies and so their share price doesn’t tend to increase as much as some of the others do.

Just like with property, the heavy lifting in shares tends to happen in the area of capital gains.

In addition, dividends are subject to tax. Even if you keep your investments in a tax sheltered account to avoid income tax, you still may be liable for withholding tax which is typically somewhere between 15 and 30%. Expats in particular need to be aware of this.

Whilst this is a bit of a sweeping statement and won’t be 100% accurate for everybody all the time it will be most of the time.

Generally, UK expats should usually choose ETFs domiciled in Ireland. Other choices (including the US) typically levy a much higher rate of withholding tax.

Index funds & ETFs available in the UK

Here’s a list of index funds you could buy. The number in brackets is the fund ID or ticker. You can use this to find a fund on your investment platform.

The OCF is your ongoing charges figure. It is charged annually as a percentage of the balance you have invested in that fund. £10k invested in a fund with an OCF of 0.05% means it is costing you £5 annually to invest in that fund.

Except for those listed under Small UK Companies, all funds listed below can be considered pretty low cost. All things being equal though, lower tends to equal better.

For expats without access to traditional index funds look for ETF in the name.

Large UK companies (including FTSE100 trackers & funds that contain all sizes)

• HSBC FTSE All Share Index Fund Institutional (GB0030334345) OCF 0.02%
• Lyxor Core Morningstar UK ETF (LU1781541096) OCF 0.04%
• L&G UK Equity ETF (IE00BFXR5R48) OCF 0.05%
• iShares UK Equity Index Fund D (GB00B7C44X99) OCF 0.05%
• Fidelity Index UK Fund P (GB00BJS8SF95) OCF 0.06%
• HSBC FTSE All Share Index Fund C (GB00B80QFX11) OCF 0.06%
• Vanguard FTSE UK All Share Index Unit Trust (GB00B3X7QG63) OCF 0.06%
• iShares Core FTSE 100 UCITS ETF (ISF) 0.07%
• Vanguard FTSE 100 UCITS ETF (VUKE) 0.09%

Medium Sized UK companies (including FTSE250 trackers)

• Amundi Prime UK Mid and Small Cap ETF (PRUK) OCF 0.05%
• Vanguard FTSE 250 ETF (VMIG) OCF 0.1%
• HSBC FTSE 250 Index Fund C (GB00B80QG052) OCF 0.12%
• iShares FTSE 250 UCITS ETF (MIDD) 0.40%

Small UK companies

• Schroder Institutional UK Smaller Companies Fund (GB0007893984) OCF 0.52%
• JP Morgan UK Smaller Companies Fund (GB0031835001) OCF 0.6%
• Baillie Gifford British Smaller Companies B Fund (GB0005931356) OCF 0.67%

Global trackers

• HSBC FTSE All-World Index Fund C (GB00BMJJJF91) OCF 0.13%
• iShares MSCI ACWI ETF (SSAC) OCF 0.20%
• Fidelity Allocator World Fund W (GB00B9777B62) OCF 0.20%
• Vanguard FTSE All-World ETF (VWRL) OCF 0.22%
• Vanguard LifeStrategy 100% Equity Fund (GB00B41XG308) OCF 0.22%
• Vanguard FTSE Global All Cap Index Fund (GB00BD3RZ582) OCF 0.23%

Developed world trackers

• Amundi Prime Global ETF (PRWU) OCF 0.05%
• L&G Global Equity ETF (LGGG) OCF 0.1%
• Lyxor Core MSCI World ETF (LCWL) OCF 0.12%
• Vanguard FTSE Developed World ETF (VHVG) OCF 0.12%
• SPDR MSCI World ETF (SWLD) OCF 0.12%
• iShares Developed World Index Fund D (IE00BD0NCL49) OCF 0.12%
• Fidelity Index World Fund P (GB00BJS8SJ34) OCF 0.12%

Intermediate duration UK bonds

• Lyxor Core FTSE Actuaries UK Gilts ETF (GILS) OCF 0.05%
• Invesco UK Gilts ETF (GLTA) OCF 0.06%
• Vanguard UK Gilt ETF (VGVA) OCF 0.07%
• iShares Core UK Gilts ETF (IGLT) OCF 0.07%
• Fidelity Index UK Gilt Fund P (GB00BMQ57G79) OCF 0.1%
• iShares GiltTrak Index Fund (IE00BD0NC250) OCF 0.1%

Short duration UK bonds

• Lyxor FTSE Actuaries UK Gilts 0-5Y ETF (GIL5) OCF 0.05%
• Invesco UK Gilt 1-5 Year ETF (GLT5) OCF 0.06% 
• L&G UK Gilt 0-5 Year ETF (UKG5) OCF 0.06% 
• iShares UK Gilts 0-5 ETF (IGLS) OCF 0.07%

Global bonds

• iShares Core Global Aggregate Bond ETF (AGBP) OCF 0.1% 
• SPDR Bloomberg Global Aggregate Bond ETF (GLAB) OCF 0.1%
• Vanguard Global Aggregate Bond ETF (VAGS) OCF 0.1%
• Vanguard Global Short Term Bond Index Fund (IE00BH65QG55) OCF 0.15%
• Vanguard Global Bond Index Fund (IE00B50W2R13) OCF 0.15% 

What are the best UK index funds?

As we’ve already mentioned most investors would do well to have stocks and bonds in their investment portfolio.

As a result, it makes sense to invest in a fund that contains both so for most UK residents the best index funds to invest in would be one of Vanguard’s LifeStrategy series funds.

These are low-cost, one-stop-shop portfolios that provide broad exposure across geographies and asset classes. You get stocks and bonds in one index fund. There are five basic funds in the range as follows:

• Vanguard Life Strategy 20% equity fund
• Vanguard Life Strategy 40% equity fund
• Vanguard Life Strategy 60% equity fund
• Vanguard Life Strategy 80% equity fund
• Vanguard Life Strategy 100% equity fund

Whilst these are traditional index funds, rather than ETFs there are European equivalents in ETF format. These would be available to expats. The only downside is that they are Euro focused. Perfect, for expats in Europe. Perhaps, also perfect for expats with plans on retiring there.

If you don’t live in Europe you’d need to think about whether or not you wanted to take on currency risk (discussed above). You might feel having everything in one fund is worth the risk. You may not. You can always put together something very similar with two funds ie one for stocks and the other for bonds.

If you are interested, the percentage figure indicates the percentage of your money invested in stocks. So using the 4% rule discussed above. If you were investing for 10 years you’d choose a Vanguard Life Strategy 40% equity fund.

They all have OCFs of 0.22% although depending on which one you choose, on paper its possible for transaction costs to add 0.01% which means you’d pay 0.23%.

They come in accumulating and distributing varieties. Accumulating being where dividends are automatically reinvested in the funds rather than being distributed to your investment account as cash.

You can see the funds here. (And rest assured we have no connection to Vanguard by the way, they just provide great low cost index funds).