A couple of weeks ago, I was having drinks with a friend from the finance industry. The conversation turned to passive investing and we spent a bit of time discussing one particular index fund in my portfolio.
The following morning, he texted me with a simple question:
“How do I find a fund that will give me the same exposure?”
It should have been a very easy question to answer. However, what actually followed was a highly frustrating sequence of WhatsApp messages and phone calls.
It took us the better part of the morning to find a simple tracker fund in my friend’s brokerage account.
As it often happens with many other things in life, when it comes to index fund investing the last step is often the toughest.
You have done your research and are convinced of the merits of passive investing. You have gone ahead and opened an account with a low-cost brokerage. You have even figured out the difference between VTI and VTSAX – and deposited some money.
And then, just when you are finally ready to hit the big red button, you realize that the biggest question remains unanswered:
Which Index Fund Do I Actually Buy?
There is a reason for that, of course. In a world where trading fees have finally begun to vanish, brokerages are even more focused on finding alternative sources of income.
One solution is to act as a bank and try to make money on the cash balances your investors hold with you.
Another one, of course, is to go back to the basics of making money in the brokerage business: selling people like you and I expensive financial products we don’t need.
And that is precisely why you rarely see low-cost, passive investing products featured prominently on the home page of any brokerage. Instead, they are usually hidden way behind the hundreds of shiny, expensive and utterly useless actively managed options.
So how do you cut through the noise and find the right index fund to put your money in?
As my experience above has shown, even someone with 15+ years of stock market investing experience can struggle to find the right product.
So a few days later I sat down on a rainy Saturday afternoon to put together a step-by-step guide to finally getting your passive investing journey underway.
To do that, I will replicate the steps necessary to find – and invest in – an index fund that tracks the performance of the S&P 500.
An Aside – Why Did I Choose The S&P 500?
If you go back to the basics, the core idea of index fund investing is to put your money into a globally diversified portfolio of equities.
So why am I choosing the S&P 500 instead of a more diversified index such as the S&P Total Market or the FTSE All World Index?
There are three reasons for this:
When it comes to investing, it’s important to keep things simple. Otherwise, chances are you will never get started.
S&P 500 tends to be a good index investment for beginner investors because of its ubiquity, simplicity and the sheer number of index funds that track it.
2. Global Diversification
According to S&P Dow Jones and Factset, the S&P 500 constituents generate c.25% of their revenues from outside the US.
Therefore, even though you are technically investing in a US index, you are getting a considerable amount of global exposure.
3. Better Governance
Very few regulatory regimes in the world offer the same level of shareholder protection as the US.
So while exposure to global equities is great, it often comes at the price of shareholder value leakage due to management corruption and mismanagement.
Petrobras is a great example.
Sure, the same issues could always arise at an S&P 500 constituent. However, I see that as much less likely given the level of public scrutiny and oversight these companies are under.
Of course, if you want to invest in a UK or a global tracker, that’s perfectly fine and you can still follow all the steps below.
A Step-by-Step Guide To Finding The Right Index Fund
Because I already have an account with Hargreaves Lansdown, this will be the brokerage I will use in this guide.
However, you should be able to follow broadly the same steps even if you have an account with other brokerages.
Let’s get started!
Step 1: Search for funds investing in North America
This is the simplest bit. Go to Hargreaves Lansdown and log into your account. You will be presented with this screen:
Click on Funds at the top of the page (see big red box above).
You will be redirected to the Funds – Prices and Research page that looks like this:
Click on the “Search By Sector” dropdown box and choose “North America”:
Once you have done this, you will be presented with a long list of funds that invest in North American equities. As a matter of fact, the list that popped up on my screen had 132 names on it!
Most of these will be actively managed funds with convoluted naming conventions and strategies.
With names like “Artemis US Extended Alpha (Class I) (Acc)”, it’s no wonder people get confused!
So what we need to do now is whittle down the long list of names to just a handful of funds that actually fit our objective.
Step 2: Shortlist the funds by company name and annual charge
Thankfully, this step is much easier than it sounds.
On the left-hand side of your screen, you will have an option to sort through the funds by choosing the investment company that offers them:
Expand the menu by clicking on “View All”. Then choose the three most prominent companies offering passive investing products. These are:
The list of funds should reduce from 132 to about twenty.
However, we can shorten it further still.
Please go the “Refine” column on the left-hand side of your screen again. Scroll down to the “Charges” section and under “Ongoing Charge (OCF/TER)” heading click the box next to “<0.5%”.
Anything with an annual charge of 0.5%+ is likely to be either actively managed or a very expensive passive product. If you’ve gotten this far, you probably know that’s not a good thing.
Now that you’ve selected the “<0.5%” option, your list is down to a much more manageable 9 index funds:
Take a quick look at the list.
The one that immediately jumps out is the “Vanguard US 500 Stock Index (Acc)”. Click on the fund name, which will take you to the fund overview page.
Look for the “Fund Objective” section and sure enough, this is what you see:
Let’s now scroll through the other 8 funds to see if any others have the S&P 500 as the underlying benchmark index.
Sure enough, there are two others:
- Fidelity Index US Class P – Accumulation
- Fidelity Index US Class P – Income
At this stage, you may be wondering what “Accumulation” vs “Income” is.
The answer is simple. In an Accumulation fund, all the dividends are automatically reinvested. In an Income fund, all the dividends are paid out to fund holders (i.e. you), as income.
Hence, the performance of an Accumulation fund will track the total return of the underlying index (in this case, the S&P 500). The performance of an Income fund will track the price return of the underlying index.
In this guide we are looking for accumulation units. Therefore, the two funds we have shortlisted are:
- Fidelity Index US Class P – Accumulation
- Vanguard US 500 Stock Index – Accumulation
Step 3: Compare the fund charges
If you click on the fund name, you will be taken to a fund overview page.
On the left-hand side of this page, you will see a comparison of initial and underlying charges. As we all know, lower is better.
Neither fund has an initial charge, but when it comes to an annual charge, the Fidelity fund has a charge of 0.06%, which is significantly lower than the Vanguard annual charge of 0.25%.
Should we go ahead and buy the Fidelity fund?
Not yet – we have one final check to do.
Step 4: Check fund tracking error
When it comes to passive investing through index funds, it’s important to make sure that the funds you are buying do a good job of tracking the underlying benchmark index.
There will always be a small discrepancy, which is also known as a tracking error. It is the job of the fund manager to minimize this tracking error.
So before we buy the Fidelity fund, let’s see how well it has been tracking the S&P 500. To do this, go to the Fidelity fund overview page and click on “Charts and Performance”:
Scroll down the page and under “Add to Chart” tick the box next to “Index”. Then choose the S&P 500 from the dropdown menu and tick “Total Return” under “Chart Options”:
You should get a chart that looks like this:
The orange line is the performance of the Fidelity fund while the blue line denotes the performance of the S&P 500 over the same time horizon.
As you can see, the two have moved in unison for an extended period of time. This means that the tracking error is minimal.
Alternatively, you could click on “Key Features And Documents” on the fund overview page, download the Fund Factsheet and check the tracking error statistic in the document.
Voila – the tracking error stands at about 0.06% over the past three years:
There you have it.
In just four easy steps and less than 10 minutes, you found an index fund that tracks the benchmark index you wanted to get exposure to, has the lowest fees and a minimal tracking error.
You are done.
All you need to do now is actually buy the fund. You can do that by clicking on “Invest Now” and following the instructions:
Happy (passive) investing!
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14 thoughts on “How To Find The Right Index Fund In Just Four Easy Steps”
Honestly this article is exactly what I have been looking for after opening my first share dealing account, not with Hargreaves through unfortunately, but I’m hoping I can follow the same steps with AJ Bell
I heard great things about AJ Bell so think you are in good hands with them.
The reason I picked Hargreaves is I already have an account with them but as you say, hopefully the process isn’t so different between the two.
why funds and not ETFs? I may be mistaken but I thought once the value of account becomes large the costs of platform charges by brokers becomes excessive, whereas ETFs being shares usually have lower platform fees.
You’re spot on. What I had in mind was an ETF tracking the index, I just happened to use North American parlance for it.
I was wondering, since keeping management charges to a minimum seems to be a feature of the “passive index funds” approach to investing, how do you justify the 0.45% platform fee charged by Hargreaves Lansdown?
Good question. Reason I use HL is that they actually don’t have a fee if you buy ETFs, which is what us passive investors do (https://www.hl.co.uk/investment-services/fund-and-share-account/charges-and-interest-rates)
The fee does apply on a SIPP, but it’s capped at £200/year which surprisingly happens to be cheaper than Vanguard (https://www.hl.co.uk/pensions/sipp/charges-and-interest-rates)
Aha! Good to know 🙂
I’d clocked that the management fee was waived for investment trusts but hadn’t seen that applies to ETFs as well – thanks for pointing out!
If you click the “COSTS” tab on the fund page for both of the above ETFs (Fidelity and Vanguard) it includes the HL management charge of 0.45% in the costs – is that a mistake?
I think the mandatory disclosure rules around fees have gotten much more stringent, hence the likes of HL have to flag the platform fee as well.
What I often do is send them a quick message to confirm the true all in cost. They are usually pretty prompt to respond and it’s a worthwhile use of time given how meaningful the fees can be over time.
A bit of a broader question, although still related.
I am following a simple dollar-cost averaging approach, investing in ETFs for the long-term. Since I am young (25 y.o.) I have the time advantage, so my portfolio consists mostly of stocks (in form of ETFs).
I am using the stock market for long-term wealth building and my goal would be to FIRE, hopefully, within 15-20-25 years.
I have recently read the book Your Money or Your Life (which I consider the “bible” of FIRE, highly recommend it).
The following caught my eye: “over the past ninety years, the stock market has taken five big hits (32 to 86 percent) with recovery times afterward ranging from four to twenty-seven years”
– Great Depressions: down 86%, 27 tears to recover
– Mid 1970s: down 47%, almost a decade to recover
– Late 1987: down 32%, 4 years to recover
– Great recession, 2007-09: down 50%, 6 years to recover (or 14 years if you count from the matching dot-com peak in 1999).
I am aware that market cannot be timed, that I should diversify, that I can allocate more to stocks if there are significant number of years ahead of me and I am also aware of the fact that if I am in for the long-term I can come out of downturn (even use them as a buying opportunity) and get a nice average.
But still for some reason this gets me worried. What if history repeats itself and we get into a heavy market downturn which takes 10/20/30+ years to recover? FIRE doesn’t really work anymore…does it? Is it reasonable to worry about this?
Could you please share you thoughts on this? I would highly appreciate it.
Thanks for the great articles!!!
Thanks for the kind words. It’s a very sensible question to ask yourself, irrespective of where you find yourself on the “journey”.
I probably won’t be able to do it justice in a single comment as it merits a separate post. Let me think it through and come back with some reflections in a post over the next few weeks.
May I ask if you are investing in accumulating or distributing ETFs?
I live in the Netherlands where there is no (tax) advantage of investing in either of them. I started building my portfolio with accumulating ETFs, given that my portfolio is relatively small – around EUR 5K, DCA-ing with EUR 500 per month – so it would be a pain (at least, to my understanding) to reinvest those tiny dividends myself that I get from the SP500 constituents.
You often talk about passive income. My long-term goal would be to build a number of passive income sources. However, accumulating ETFs got me thinking: I will never really see any dividends as they’re reinvested. Isn’t it then better to go with the distributing ETF, reinvest those dividends over the years (even if initially it’s somewhat difficult given the tiny dividends you get), and then later when your portfolio is big enough, it will generate you passive income that I can either decide to reinvest or use the cash?
For me it seems like accumulating ETFs are a better tool to build wealth for retirement, for instance, when you need to touch the principal. What’s your take on this? I’d be happy to curious to hear it.
I usually go with the accumulating version, just to keep the complexity (and transaction costs down).
My logic is that I have a pretty good handle on how much “passive” income my stock portfolio can spit out. Depending what you believe, it’s either the SWR (4%), or the dividend yield on the index you are invested in (~2% for the S&P 500).
The way I look at it, retirement is still ways off and once I get there, my asset allocation may well look quite different. Hence, I’d rather simplify my life until I get to that point.
Brilliant post, very informative and guiding.
Would you be able to give an insight to the process to use/you use for an ETF to narrow it down?
I find HL website is restrictive in being able to carry out a similer comparison for an ETF.
Thank you for all the posts 🙂
It depends on what you are looking for.
There are ETF screening tools out there that are not brokerage specific: https://www.justetf.com/uk/
So you could use those to zoom in on ETFs that are of interest and then check whether they are offered in your brokerage. It will take some matching of ETFs and brokerages, but I’d be surprised if a well-established platform didn’t offer an ETF you are looking for
Hope this helps!