52,721 reasons why passive funds belong in your Stocks and Shares ISA

52,721 reasons why passive funds belong in your Stocks and Shares ISA

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52,721 is how much it would cost you in pounds to buy one share of each company that makes up the largest stock market by value in America and the world, the S&P500, using prices as of 18th November 2019. That’s without trading costs, which even at a low £5 per trade would add £2,500 on top of an already large number.

If you have less than £52,721 in your Investment Plan at Wealthify, guess what? You still own a small part of every company in that US stock index, from tech superstars like Google, Apple and Netflix, to your long-lasting, household brands, such as Walmart, Coca-Cola and McDonalds. How is that possible? Thanks to passive funds – think of them as hampers full of investments.

PS, if you haven’t realised already, we don’t really have 52,721 reasons why passive funds belong in your Stocks and Shares ISA, instead we have 7 great reasons why…

 

Passive funds are relatively simple to understand
A passive fund will replicate the return of the financial market it is tracking. There are 500 US companies with shares publicly available for buying and selling and all together they form the S&P500. The passive fund we use tracks the US stock market and as a consequence, it will hold the correct amount of each company to replicate the returns of the S&P500. Apple for example, makes up 4.36% of the S&P500 value, so in your passive fund, 4.36% will be allocated to shares in Apple. It’s that straightforward. On the other hand, an active fund involves human judgement and analysis thrown into the investment process. Not a bad thing, especially when you want an investment plan with a specific style, like our Ethical Investment Plans, that avoid harmful activities and include companies committed to doing good. But, more generally, trying to understand why a fund manager prefers SnapChat stock over Twitter, or Ebay over Amazon, requires far more mental energy than your research on different passive fund options.

 

Passive funds can be bought at a low price
When we build your Stocks and Shares ISA, the passive funds we use are low in price. Most passive funds that replicate market returns are priced between £1 to £100 per unit to buy. At Wealthify, as part of our fund selection process, we intentionally focus on funds that are priced typically on the cheaper end of that range. And rather than having to buy a whole share, or whole cake, most of the funds that we use allow investors to purchase a slice. This could help with performance and reduce the effect of poor performance due to one underperforming stock, putting your eggs in lots of different baskets is known as diversification. However, even if you purchased an S&P500 passive fund for £100 per unit, it’s still a much cheaper price to own all these exciting companies compared to the cost to buying one share in each specific company, at a total of £52,721.

 

Passive funds are transparent about what they hold
There’s no secret sauce that the fund is trying to protect. As previously suggested, a passive fund does what it says on the tin, it holds the investments required to replicate the returns of the financial market it is tracking. Typically, at the end of each business day, you will see what the fund is worth and what it holds. Active funds however, who are paid to perform better than everyone else, will typically disclose their holdings on a quarterly basis. This is standard practise, but if you’re a successful active fund manager, why would you want everyone to see what you’re up to each day? You wouldn’t. But, as an investor, if knowing what you’re invested in more frequently than quarterly provides you with comfort, then perhaps passive funds are more suitable for building your Stocks and Shares ISA.

 

Passive funds that track large markets are easy to buy and sell
A topical point of interest in the UK investment industry at the moment is liquidity - how easily an investment can be bought and sold. There’s a certain active fund that has been in the press for holding private shares of small companies that led to its demise, and investors are now waiting to get back some of their invested money. It’s a sad moment for the investment industry that will have to try hard to rebuild trust amongst everyday investors. If the fund in question had been more transparent, and steered clear of small speculative shares, it could have ended differently.

Comparatively, most passive funds invest in mainly large companies. An S&P500 passive fund owns some of the largest, most liquid shares of companies that can be bought and sold on a stock market. Passive funds will track or replicate returns of markets where shares are easy to buy and sell because they’re designed to be a suitable investment solution for the masses.

 

Easy to build a diversified Stocks and Shares ISA
Passive funds are useful building blocks that provide access to various investment types from bonds to shares, worldwide, with relative ease. You’ll find it impossible to improve your diversification by putting your eggs in multiple baskets, using any other type of fund, because like our S&P 500 passive fund, most passive funds will own at least 100 individual shares or bonds, some passive funds will even own 1,000s of investments.

Let’s take a real-life example. Our passive Confident investment plan holds 20 funds and comfortably owns over 10,000 underlying investments in various corporate bonds, government bonds, shares and other types of investments. As well as for diversification benefits, we prefer using passive funds to build our original Stocks and Shares ISAs because they allow our investment team to focus more of their efforts on asset allocation (where we put your investments rather than how), a far more important aspect of portfolio construction when trying to generate returns for our customers.

 

Passive fund returns are hard to beat
An investor who holds passive funds in their Stocks and Shares ISA are using funds like our S&P500 passive fund that are designed to replicate the returns of a stock or bond market, minus a small fee. The practice is quite common today, but the idea of a fund that mimics a stock market delivering higher returns than stock pickers on average was purely academic until 1976. The founding father of passive funds is arguably John Bogle, the late and great founder of Vanguard Group. Over the last 30 something years, there has been growing, real evidence, that proves active fund managers on average struggle to beat the broader market. According to one study, in a 15-year investment period up to 2018, 92% of active fund managers that invest in shares of large companies in the US failed to beat the market1.

 

Passive funds are a low-cost investment product
If you’re looking for a way to buy as many investments as you can, passive funds are the kings of diversification at a low cost to the investor, even more so when talking transaction charges. Our S&P500 passive fund that owns some of the biggest and greatest companies in the world, is a real-life example of how passive funds have brought the cost of owning broad baskets of investments close to zero. Let’s take the transaction charges to buy each individual company of our S&P500 passive fund. Let’s say purchasing 500 individual shares at £5 per transaction will cost you £2,500. Comparatively, buying one passive fund that tracks the S&P500 would only cost you £5. Irrespective of whether you can afford to buy all the individual companies individually, why would you?

 

Summary
OK, perhaps there aren’t 52,721 reasons why passive funds should form part of your Stocks and Shares ISA – but there are at least 7 valid reasons why. Passive funds are easy to buy and sell, straightforward, and transparent. They’re useful and low-cost building blocks for a diversified Stocks and Shares ISA, and they can deliver strong investment returns. What’s not to like!?

1: https://www.ftadviser.com/investments/2019/02/04/active-managers-struggle-to-beat-benchmarks/

 

The tax treatment depends on your individual circumstances and may be subject to change in the future.

 

Past performance is not a reliable indicator of future results.

 

Please remember the value of your investments can go down as well as up, and you could get back less than invested.

 

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