How To Setup a Tax-Free Tracker Fund
April 2005
When asked about financial spread betting, 90% of people instantly think speculation. But what about the other 10%? Well, they've recognised that tax-free can also be a massive advantage if your outlook on the markets in more long term. And case in point is using spread bets to set up a tax-free tracker fund on say the FTSE 100 or Dow Jones 30.
Obviously with Peps one is already allowed to invest around £7,000 per year tax-free, but what if you want to invest more capital? In this case you could turn to financial spread betting.
Some Assumptions
- You are bullish towards the general stockmarket over the next few years
- You don't want to research individual stocks
- You've got £5,000 to invest
If you went to see a financial advisor he'd likely suggest putting the money into a tracker fund.
A tracker Fund is simply a fund that tracks an underlying index like the FTSE 100. If the FTSE gains 9.87% over a year, the tracker fund will also return around 9.87%. Contrast this with a fund that invests in general stocks. There is no guarantee that a general stock picking fund will make anything like 9.87%, it could theoretically lose because it invested in the wrong stocks. It could also return 25%+ by investing in the year's best performing shares.
In many ways a tracker fund takes the thinking out of investing alongside offering very cheap running costs. But like all investments of this nature profits are subject to capital gains tax.
How a Tracker Fund Works
In a simplified form a Tracker Fund invests in every stock within the index it is tracking. For the FTSE 100 it would invest in 100 shares but with different weightings. For example, it would buy far more Vodafone shares because it has a higher percentage weighting within the FTSE 100 than it would buy Boots Group shares.
Of course the private investor cannot do this because it would be far too uneconomical. If you had say £250,000 or more to invest you could always use FTSE 100 futures to mimic the index but then profits would be liable for capital gains tax.
How To Create a Small Tracker Fund
One of the beautiful aspects about spread betting is that they can be used for betting very small amounts. For example, a tick (minimum price fluctuation, from 5000 to 5001 would be 1 tick) in the FTSE 100 futures contract is worth £10. But a tick using spread bets can be worth as little as 50p. It's therefore possible to trade spread bets with a far smaller capital base.
If you are not familiar with Spread Betting or how it works then you are advised first to check out our partner site www.LearnMoney.co.uk which carries a very detailed section on financial spread betting - Click Here.
- Date 4th April 2005
- FTSE 100 cash index is 4945
- The Jun spread bet market is 4948-4956
- To invest £5,000 using spread bets simply divide £5,000 by the offer price of 4956 so giving you £1.00 a point to go long
- To double check this simulate the index dropping 10% and you should have lost £500
- 4956/10 = 495.6 x £1.00 = £495.6 (it's not exact because the actual amount per point should have been around £1.0089
What you have done is to mimic a £5,000 investment in a tracker fund by buying FTSE spread bet.
All profits are now 100% tax-free. But note that the tax-free 'advantage' can come with a sting in the tail, that being that losses cannot be offset against capital gains made elsewhere. This point should be noted with the utmost importance.
Costs & Rollover
Spread betting used to be a lot simpler. There was just one FTSE 100 market to bet on (a quarterly market, Mar, Jun, Sep, Dec) but now there are a myriad of different ones. Daily bets, rolling bets, monthly, quarterly and even yearly markets.
But as spread betting is being used to a longer term outlook it's best to use something like quarterly bets. You'll therefore be rolling the trade over 4 times a year for a cost of a few points. Finspreads the broker we use charges 2.
It's important here to know exactly what you're doing so never try this kind of investment strategy unless you fully understand the rules and application of it.
Hidden Advantages?
No commissions, they're built into the bid-offer spread. But a more subtle advantage is that because spread bets are leveraged products you only have to put up a fraction of the money to control the asset.
For example if you invested £5,000 in an M&G tracker fund you'd have to write a cheque out for the full amount. But spread bets use around 5-10% margin so to control a £5,000 FTSE 100 position you'd only have to deposit £250-£500. Note that this amount will change as the market moves higher or lower. You will also have to have some excess capital in your spread bet account in order to pay for marked to market losses if the FTSE 100 moves down. But the rest of the capital can be safely tucked up in an instant access higher rate savings account like ING Direct.
Summary
We are very surprised that many people don't use the tax-free advantage of spread betting for longer term investing. The current thinking is that all spread bets are good for is taking a 10-30 points out of FTSE on a given day.
But we contest this view because utilising Spread Bets for longer term strategies such as creating a tax-free tracker fund makes a lot of sense. You may not want to create a tracker fund yourself but this exercise should have been worthwhile nevertheless because it has hopefully given new ideas as to how leveraged products can be used in ways first not thought.
One final point. Spread bets carry no currency risk, they are all quoted in Pounds/Pence per point. Therefore it's possible to set up many different tax-free tracker funds on different global markets such as the German Dax, French Cac40, Italian MIB, US Dow Jones, Japanese Nikkei and Chinese Xinhua 25, all denominated in Pounds.
See Also
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