Which Index Funds Should You Invest In
- The Millennial Millionaire
- Dec 20, 2020
- 5 min read
When it comes to investing – you’ll likely have heard from many sources, including myself, that the worst thing you can do is save your money – which I go through here. Investing in index funds is a fool-proof way to make a good, consistent, and long-term return on your money.
However, once you’ve decided to invest in index funds, you may be asking: ‘Which ones should I pick?’.
This blog will go through my opinion on the best funds to invest in for future growth. But, bear in mind that the mix of these funds or others will depend on your appetite for risk amongst other things.
The Principles
The things to consider before investing include the:
· Annual Charge
· Future Expected Return
· Future Expected Risk
We want investments that have the largest returns, with lowest risks and lowest fees.
Your Personal Portfolio
The future expected return and risk will be specific to you. For example, if you think that tech stocks are the future, you may wish to have more money in the US tech stocks that seem to trade largely on the Nasdaq stock exchange – so an index based off of this may be your preference. Others may think that these stocks are overvalued – and wish to have less exposure overseas, sticking to UK stocks.
In the rest of this blog – I’ll outline my favourite mix of index funds and the reasoning for it. However, this is just my opinion and not financial advice.
UK Exposure
There are many reasons to have UK exposure in your portfolio. I want my portfolio to have a 50% weighting of UK stocks, because:
· Investing in the UK markets prevents the currency risk associated with investing abroad. For example, if you invest in the US markets and they go up 20%, if the GBP to USD exchange rate depreciates, you won’t receive that 20% return – you will see it as potentially 10% in your portfolio. Therefore, I think it’s better to invest a large proportion of your money in domestic markets. Of course, this could go the other way and you could end up getting a larger than 20% rate of return.
· The UK markets seem undervalued when compared to other developed markets. Currently the FTSE trades around a 15-20 P/E Ratio, which may seem high – however compared to US markets it seems far less overvalued. To understand more about these ratios and the types of investing – I have a separate blog on it here.
· The UK market hasn’t seen the same growth as the US market – it currently trades lower than the highs it reached in the year 2000. I therefore think there is now opportunity for more growth. In the same time, the US 500 biggest stocks on the S&P 500 have more than doubled to the prices we see today. My opinion is that the UK’s time will come soon – especially after trading sideways for so long.
Within the UK market however, the FTSE 100 has many companies that are not really growing at a great rate anymore. The FTSE 100 contains the 100 biggest, publicly traded companies in the UK. Therefore, I prefer to have a larger exposure to the FTSE 250. These are the 250 biggest, publicly traded stocks that are not in the FTSE 100.
As I like half my money to be in domestic stocks – my perfect portfolio would have 30% in the FTSE 250 Index, and 20% in the FTSE 100 Index.
US Exposure
The US market has really boomed in the last couple of decades – some of the most exciting companies in the world are based in the US. This includes Google, Facebook, Tesla, Twitter, Apple and so on. The fact is that the biggest and best companies are in the US at the moment.
These companies are massive – but the scary thing is that their growth is expected to continue into the next decade. However, the S&P 500 has many stocks that, like the FTSE 100, are not high growth companies. Therefore, when it comes to US exposure in my portfolio, I’d want to have more weighting to the Nasdaq, which is far more tech heavy and thus more exciting in my eyes.
Therefore, when it comes to US exposure, I’d want 15% in the Nasdaq Index, and 5% in the S&P 500.
Emerging Markets Exposure
The developed world has seen some incredible companies created recently – however the real growth is happening now in the emerging markets. These markets are more risky due to:
· Less regulation in the markets
· Political Instability within the countries
· Risk of limited / banned overseas investment
· Currency Risks
However, with more risk generally comes more return – so if you’re able to diversify your emerging markets investment, like through an index fund, you may see the best returns.
Therefore, I’d want 30% of my portfolio to be in emerging markets.
Accumulation vs Income Funds
When investing in the above funds – most of the time you have the option to invest in Accumulation or Income funds.
Income funds pay out the dividends which the companies pay as cash. This allows you to then use that money however you wish.
Accumulation Funds on the other side are designed for growth – therefore the money paid out in dividends is automatically reinvested into the fund – this is the option I opt for as I have no intention of using the invested money anytime soon.
The Final Portfolio
Using everything above and putting this into a portfolio – this is what I believe to be my ideal mix of index funds (Index / Percentage of Portfolio / Example of Fund):
· FTSE 250 Accumulation / 30% / HSBC FTSE 250 Index
· FTSE 100 Accumulation / 20% / Vanguard FTSE 100 Index
· Nasdaq Composite Accumulation / 15% / Fidelity Nasdaq Composite Index
· S&P 500 Accumulation / 5% / Vanguard US 500 Stock Index
· Emerging Markets Accumulation / 30% / Fidelity Index Emerging Markets
These are all relatively low cost funds.
This sort of portfolio reflects what I think will do well in the long-term. However, your portfolio may differ if you have more confidence in US / Emerging/ UK Markets. There are also other markets out there to consider, such as other European markets / Japanese markets. You may wish to consider these when building out your portfolio.
Also, as we get older, we’d want to de-risk portfolios in order to get ready for retirement. At that point you may start investing more in bonds or decide to keep part of your portfolio in cash.
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