The end of the tax year is fast approaching and if you’ve not used up your enlarged ISA allowance of £15,240 then now is the time to capitalise on this tax-free wrapper.
However, with the market trading at record highs, I’m worried about a possible correction. So, rather than trying to second-guess the market, and pick stocks, I’m going to buy the market as a whole. In the words of John Bogle, founder of Vanguard and index fund pioneer: “Don’t look for the needle in the haystack. Just buy the haystack!”
Popular method
Using an index fund to track the performance of the FTSE 100 has become an extremely popular way of investing over the past few years. This method of investing has even been advocated by the Oracle of Omaha, Warren Buffett, as it’s often the case that active asset managers fail to provide value for money. Last year, within his annual letter to Berkshire Hathaway shareholders, Warren Buffett gave us a glimpse into his retirement plan.
Actually, it was not advice for his retirement but rather advice for the trustee whose duty it will be to administer the money Buffett is leaving for his wife — the majority of Buffett’s wealth will go to charity. Here’s Buffett’s advice:
“My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund.”
The logic behind this statement is simple. Over the past 20 years, the FTSE 100 has risen at a rate of around 5.4% per annum, excluding fees, dividends and inflation — dividends received are likely to cancel out fees and inflation anyway.
Further, the FTSE 250 has racked up annual returns of around 11% for the past 10 years. Over this period the market has negotiated one of the worst financial crises in history.
In comparison, over the same 20-year period, according to research conducted by a number of financial institutions, the average investor has only returned 2.5% per annum including dividends.
The best method
So overall, the figures show that if you want to achieve the best rate of return for your money, tracking the index is the way to go. And when you consider the paltry rate of interest offered by most cash ISA providers, the FTSE 100’s average dividend yield of 3.5% is extremely attractive. The FTSE 250’s yield stands at 2.5%.
This is why I’m buying a low-cost FTSE 100 and FTSE 250 tracker for my ISA. Granted, the funds won’t make me the next Warren Buffett but they provide a low-risk, effortless way of achieving above-average returns!