Three cheap index trackers

Beat low interest rates with one of these low-cost ISA index trackers, says Malcolm Wheatley.

What's going to happen to interest rates? I don't know, and neither does anyone else. Predictions abound, but no one really knows -- not even top economist Roger Bootle, who said last week that interest rates could well remain below 1% for five years.

One thing is certain: whatever does happen to interest rates, it will be a long time before inflationary pressures prompt the rate-setting Bank of England monetary policy committee to push rates back up to the sort of levels that savers were enjoying in 2007 and 2008.

Which prompts a worrying question:

Does a cash ISA make sense?

Cash ISAs are undoubtedly popular. According to the Office for National Statistics' ground-breaking Wealth in Great Britain research, 36% of British households have opened a cash ISA. On average, these ISAs contain about £6,000.

And new rules, which you can learn about in this free guide, will allow us to save even more money in them, come April.

But do cash ISAs actually make sense? We'll, let's face it, the returns on offer at the moment -- introductory 'teaser' rates apart -- aren't much to get excited about. As we explained last week here at lovemoney.com, to get the best rates, savers are increasingly having to lock their money away for fixed terms -- and even then, you're looking at a rate of just 3.5% or so.

In such a low-rate environment, cash ISAs serve just two purposes:

• First, experts advise spreading your wealth across several 'asset classes' -- property, cash, shares, bonds and so on -- and cash ISAs are a good tax-free home for the cash part of that asset allocation.

• Second, cash ISAs also make sense as a convenient place to stash 'emergency money': money that you want to have ready access to, in the unlikely event that it will be needed, but which you don't particularly want to pay tax on while you squirrel it away.

So what's the alternative?

I'm a great fan of stocks and shares ISAs, having saved in them for over a decade. That puts me in a significant minority: according to that Wealth in Great Britain research, just 10% of British households have a stocks and shares ISA.

But despite the name, most of the money that I have in stocks and shares ISAs isn't in individual stocks and shares. Instead, it's in index trackers: low-cost 'baskets' of shares, that collectively track the ups and downs of a given stock market index -- the 100-share FTSE 100, for instance, or (preferably) the rather more broadly diversified 600-share FTSE All-Share index.

Some people are put off by those stock market ups and downs, of course. And to them, one of the great attractions of savings accounts is that there are no downs, and so, no risks. Your savings pot always goes up, as interest mounts.

Higher growth

But in the present low-interest environment, those savings accounts are going to grow only very slowly. The long-term trend of the stock market delivers a much, much greater growth -- and index trackers offer an easy way to tap into this.

Historically, for instance, the FTSE All Share, on a 'dividends re-invested' basis, has grown at around 11% a year. At that rate, savings of £100 a month turns into almost £46,000 after 15 years.

That sort of return comfortably beats the returns offered by savings accounts -- and in fact, the prestigious annual Barclays Equity/ Gilt study shows that, based on the past 92 years, shares will outperform savings accounts 99% of the time. That's good enough for me.

Low costs matter

But when buying an index tracker, low costs are key. Running an index tracker is an easy task for a fund manager -- computers do much of the work -- and there's absolutely no reason for paying over the odds. Almost unbelievably, some firms charge 1.25% or more in annual management fees, while others charge just a fraction of that.

So here are the UK's top three low-cost FTSE All Share index trackers, together with their Total Expense Ratios (TER). There's no mystique about TERs: they're simply a more representative indication of true cost than the simple annual management fee that some companies quote.

In a future article, I'll explain more about TERs, and why they matter -- but today, here are those top three low-cost FTSE All Share trackers.

Compare index trackers at lovemoney.com

As I've said, other providers can be much more expensive -- Virgin's TER is over 1%, for instance, which makes them four times as expensive as HSBC.

One other point to note: Vanguard, the massive US fund manager which came to the UK last year, is famed for its low charges, but has elected to charge investors the upfront Stamp Duty Reserve Tax that other trackers pass on by holding back some of the dividends that they receive. So if you're intending only a short term investment of less than five years, the HSBC tracker is cheaper overall.

Remember, you can also invest in index-trackers via your SIPP, as well as via a stocks & shares ISA. Speak to your pension provider to find out what's on offer.

Finally, if you want some more guidance on how to get into investing in the stock market, why not adopt our goal: Make money from the stock market, or head over to Q and A to ask other lovemoney.com readers for tips on what worked best for them. And don't forget to check out our sister site, The Motley Fool, for specific help on top shares to invest in.

Compare index trackers at lovemoney.com

Full disclosure: Malcolm holds both Vanguard and HSBC index trackers.