HOW TO CREATE A TAX FREE TRACKER FUND

Back in the February issue of the Newsletter we touched on how to use Spread Betting to create a tax-free Tracker Fund on the FTSE 100 index. Recently a subscriber contacted us asking if we could go into more detail on these types of strategies. Looking into the method again we're very surprised that this kind of trading hasn't taken off because it shares all the advantages of a tracker fund offered by say Fidelity, but with even cheaper costs and zero tax on gains.

The subscriber asked us how he could use spread bets to invest in the market over time. Let's assume he wants to invest a lump sum of £5,000 in the stockmarket alongside a regular monthly contribution of £150. Therefore at the end of year one he'll have invested a total of £6,800.

How a Tracker Fund Works

One of the problems that investors have found over time is picking the right stocks. There is nothing worse than seeing the overall FTSE 100 index moving up 15% for the year only to see your portfolio of stocks move up just 5%. Or the market falls 10% over a year but your portfolio falls 20%.

It is also a well known fact that the majority of fund managers are never able to beat the indexes and this is another reason why Tracker Funds have proved so successful over the last 5 years. Tracker Funds cut out the middleman (Fund Manager) so to speak. Instead of relying on his or her judgement money is invested straight into the FTSE 100 itself.

One way to do this is to buy every stock constituent alongside its relative weighting. For example you would buy far more Vodafone stock than a 'smaller' FTSE 100 stock like Boots. Investing this way means that whatever the index does it's impossible for the fund not to 'track' the index almost perfectly. Management fees are also a lot cheaper because there's little trading to do (stocks don't fall out or enter the FTSE 100 index every month) and even less thinking.

Buying every stock within the index is not possible for the majority of investors but there is a far simpler way to create your own tracker fund, just buy the FTSE 100 futures. The futures will also almost perfectly track the index so if the index is up 1.34% over a week the futures will also be up around 1.34%.

However the FTSE 100 futures control a sizable amount of stock so they are not appropriate for the majority of investors. One point in the FTSE futures is worth £10 so if the index is trading at 4,500 one future is the same as investing £45,000. But as we all know one of the beauties about spread betting is the ability to trade the markets in very small size, as low as 10p a point.

Tax Free - Advantage Or Not?

The tax-free advantage that the spread bet companies businesses are built on is certainly a major plus but only if you actually make money. If you lose over time, especially big money then 'tax-free winnings' can create serious problems because the losses cannot be offset against personal capital gains made elsewhere.

Many people new to trading or speculation think that spread betting and the tax-free angle is the answer to their prayers but they often fail to realise how hard it often is to make money over time. Perhaps they'd be better advised to trade CFDs or products where losses can be of some value while learning the ropes. Then after a period of profitable trading switch over some of their trades to spread bets where they can be far more confident of taking advantage of the tax-free advantage.