Investing in index funds is a popular choice for investors worldwide, especially beginners. In fact, there’s over £5 trillion invested in Vanguard’s index funds alone. In a nutshell, an index fund is a low-cost portfolio of shares or other assets (like bonds) that tracks an industry benchmark or market index.
Here’s a simply step-by-step guide explaining how you can start investing in index funds:
Index funds are collections of stocks that are designed to reflect the companies that are listed in a specific index. By investing in an index fund, you get exposure to each stock in the fund, without having to go through the process of buying each stock individually.
Index funds are often passively managed, which basically means not much work goes into maintaining them. The benefit of this is that it can lead to lower investing costs which (should) get passed on to you. So, index funds provide a cheap and simple way for you to invest in a whole basket of stocks with minimal oversight.
When you invest in an index fund, you purchase a stake in all the companies that the fund holds. When stocks in a fund change, for example if a stock moves out of the index and another moves in, your holdings change too. Stocks move in and out of indices regularly, so your index fund will automatically rebalance and reshuffle to reflect any changes.
While you could get exposure to all of the stocks in an index by buying shares in each company, buying an index fund could save you time, effort and (potentially) money. Not only is it quicker to buy a fund, you also don’t have to worry about selling and buying stocks to reflect changes in the index.
Plus, if you wanted to buy shares in say, every company on the FTSE 100, you’d have to pay a commission for 100 trades, which could set you back hundreds of pounds. When you buy a fund, you pay a single, annual fund management charge.
A stock index is a collection of stocks listed on one or more exchanges. In the UK, the most well-known stock index is 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).
The most well-known stock market index would probably be the S&P 500 from the US. Stocks within the S&P 500 index are listed on both the New York Stock Exchange (NYSE) and the Nasdaq exchanges. A stock market index can provide a useful snapshot to investors of the overall performance of a particular market or collection of stocks.
This is for you to decide. The best index for one person to invest in might not be the best for another. So, as with all investing, it’s a case researching and choosing the index (or indices) that best aligns with your investment goals, strategy, and risk appetite.
What we can do is give you an overview of some of the world’s leading stock indices popular amongst index fund investors, these include:
This is only the tip of the index iceberg. There are many more, so you’re bound to find one that suits you. And for every index, you’ll also have a choice of index funds to invest in. This choice will often come down to which ones are available via your chosen platform, and what the fund costs are.
Leeds
I made my first investment when I was 19. The first investment I ever bought were shares in an index fund, the Vanguard FTSE All-World ETF (VWRA). At that time, I was greatly influenced by books on investing. Before I read those books, I thought stock-picking was simple. I even planned to purchase some shares of top companies like Tesla and Alphabet. However, as I read more, and my knowledge about investing grew, it soon dawned upon me that picking individual stocks was a demanding task. I had to read through financial statements, keep up with company news and value the stock. I didn’t have time for that. All of us lead busy lives.
The more I read, I came to find out about this passive investing strategy which was index fund investing. The gist of it was to make monthly purchases of a mutual fund or ETF that tracks an index, then hold it and let time work its magic. With little time on my hands, I figured out a passive investment strategy would work for me. Just set it and forget it, right? After some research and reading, I decided to go with VWRA which tracks the global stock market. That’s my story of how I started investing, and how I want to continue investing. Maybe I’ll stock-pick in the future, who knows?
If there's one thing you'd tell a friend who's thinking of investing in index funds, what would it be?
Stop thinking about it and do it already.
There isn’t a single overall average index fund return, because it varies by index. Plus, averages can be a bit misleading, disguising some big variations. Returns depend on the timeframe you’re looking at.
Nevertheless, holding an index fund or ETF for the long term is often the best strategy. Investment volatility typically evens itself out and results in positive returns over time, which is why we often bang on about the importance of investing for the long term.
The returns from an index fund won’t be quite the same as those of an actual index. But it should mirror it pretty closely (excluding fees).
The value of your investments could fall, as with all investing. However, index funds are considered relatively low-risk, compared with buying shares in a company. One reasons is because of diversification. Index funds can be made up from many different investments. By investing in an index fund, you’re diversifying your portfolio. This means that you haven’t put all your eggs in one basket.
Index funds are a type of passive investment. Unlike with actively managed funds, they simply mimic movements of the underlying index.
The result of this is, typically, is much lower costs for index funds than for actively-managed funds. This is one of the things that makes them so popular, particularly since index funds often perform just as well (and sometimes better) that actively managed funds.
That doesn’t mean there are no costs at all. Typically, you’ll need to pay:
Often, yes. Index funds can be a simple and straightforward option. They’re a solid building block for investors and can be easier for beginners to grasp. They don’t need much active involvement, so once you’ve picked an index fund, you can invest passively and don’t need to monitor on frequent basis. Assuming you’re planning to invest for the long-term (as all but very experienced investors should be) then index funds can be a good place to start.
While no investment is risk-free, funds can also be a lower-risk way to invest compared with buying shares or more complex investments. By investing in a fund, you’re spreading your money across a bunch of investments, which automatically diversifies your portfolio to a certain extent.
Timing the market is something that even experts struggle with, as it's so hard to predict with any certainty what will happen next. That's why you'll see most seasoned investors preach about 'time in the market'. Lots of people will be seeing stock markets and various index funds reaching all-time highs and be worried about 'investing at the top'.
The truth is, most major stock markets have remained on a long-term trajectory upwards. So, as long as you're investing with a long-term mindset, you shouldn't be worried about recent highs. Because, your goal should be that these indices and benchmarks will be higher in 5 years time, not just tomorrow or next week.
Some investment providers don’t have index 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. However, many platforms offer ETFs instead of index funds because these can be easier to access and trade.
Here are some examples of providers that will let you invest in index funds, ETFs, or both:
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.
ETFs are a type of fund that’s traded on a stock exchange. You can get index-tracking ETFs, which are very similar to index funds except for a few things. Here are the key differences between ETFs and index funds:
Learn more about the differences between index funds and ETFs
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:
Despite their benefits, there are a couple of downsides of investing in index funds. In particular:
As the name suggests, index funds are made up of the companies listed within a given index. So, the performance and returns closely mimic the performance of the index being tracked. Investing in index funds can give you exposure to multiple stocks in one fell swoop. Plus, they tend to be much cheaper than actively managed funds.
Index funds and index-tracking ETFs are often considered one of the best investments for beginners because they’re straightforward, cheap, and diversified. Even for more experienced investors, choosing to invest in an index fund can provide a solid foundation for you to build from with the rest of your portfolio.
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Can an index fund be placed in an ISA?
Hi Gilbert. Yes – we cover this in the FAQ at the end of the page: “You could invest in index funds tax free if you choose to invest in an individual savings account (ISA).”