Index funds are a popular choice of investment, especially with beginners. They give you the opportunity to invest in a group of stocks in one go, without paying a fortune in dealing fees and spending time constantly altering your portfolio. You can invest in index funds with most investment providers, such as IG, Hargreaves Lansdown and Vanguard. In a nutshell, an index fund is a low-cost portfolio of shares and other assets that tracks a financial or stock market index. Find out more about what a stock market index is, why people invest in index funds and how you can get started.
Index funds are collections of stocks that are designed to reflect the stocks in an index. Take the FTSE 100, for example. It’s made up of (you guessed it) 100 of the biggest stocks on the London Stock Exchange. Therefore, a FTSE 100 index fund would have the same stocks, or very similar stocks to the index. This means that you should get a very close performance with the index itself.
It’s as simple as choosing a provider that sells funds, as these typically offer index funds as well. When you’re ready, just sign up for an online share trading platform. To do this, you’ll need to do the following:
Need to know: Opening a Saxo share dealing account requires a high minimum investment (£500).
Read our review of Saxo.
When you invest in an index fund, you purchase a stake in all the companies that the fund invests in. When the fund is changed, such as if a stock moves out of the index and another moves in, your holdings change too.
Stocks are moving in and out of the index all the time, so the fund manager will keep tabs on the changes and change the portfolio accordingly. This saves you a lot of time since instead of buying individual shares in companies, you can invest in several at once through an index fund. It could also save you money – if you wanted to buy shares in every company on the FTSE 100, you’d have to pay a commission for 100 trades. With Hargreaves Lansdown, that would cost you £1,195 in commission alone.
Usually, with fully managed investments, fund managers buy and sell assets within that fund and attempt to predict the movements to try to earn a profit. This is known as “active” management.
Index funds are managed differently. They are a group of company stocks that attempt to mimic a financial index (explained below). Because of this, they don’t need as much intervention from fund managers, which typically saves money.
A stock index is a collection of stocks listed on the stock exchange. In the UK, we have the FTSE 100 (pronounced footsie one-hundred). “FTSE” stands for Financial Times Stock Exchange. In short, it’s the 100 biggest companies listed on the London Stock Exchange (LSE).
There are loads of different stock indices, like the FTSE 250 and the S&P 500. Investors use these to get a general picture of how healthy the market is. The values tend to rise and fall depending on economic indicators and company news. When the economy is doing really well, its stock market indices will rise in value, as investors feel confident. The opposite is also true; if investors are feeling less confident about their investments, they might decide to sell. If everyone is selling, the price will decrease. A great example of this is the sudden crash in the stock market shortly after COVID-19 was declared a pandemic.
Take the HSBC FTSE 100 Index Fund – it invests in 114 assets, made up of 97.38% in equities (company shares) and 2.62% in cash (usually held to manage day-to-day cash flow requirements).
The fund holds all of the companies that make up the FTSE 100 Index with the same or very similar proportions in which they are included in the index. Sometimes, it might not hold all of the companies, this would be to manage costs or characteristics or if there are any restrictions.
For example, here are the top 10 holdings of the FTSE 100, compared with the top 10 stocks in the HSBC FTSE 100 Index Fund, at the time of writing.
As you can see, the top 10 stocks in the index fund are virtually the same as the top 10 in the index itself.
The purpose of an index fund is to match the performance of the index, not beat it.
The value of your investments could fall, as with all investing. However, index funds are considered comparatively safe, compared to directly buying shares in a company. One of these reasons is because of diversification. Index funds are made up of hundreds of different investments, so by investing in one, you’re diversifying your portfolio. This means that you haven’t wagered all of your money on one investment.
Some investment providers don’t have funds on their platform, so it’s worth making sure the one you choose to go with does have the funds you’re interested in. Here’s which providers offer funds. If you have specific index funds in mind, most providers have a search function on their websites to see if they’ve got it.
Exchange traded funds are a type of fund that’s traded on stock exchanges. You can get index ETFs, which are pretty much the same as index funds except for a few things. Here are the key differences between ETFs and funds:
Index funds tend to do pretty well, compared with other types of investments. There are loads to choose from, and often providers will have pre-made lists with a selection of their favourites.
Here are some of the key benefits of investing in index funds:
All investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is no guarantee of future results. If you’re not sure which investments are right for you, please seek out a financial adviser. Capital at risk.
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