How to invest in index funds

Find out the benefits, the risks and how you can get started with investing in index funds in the UK.

How to invest in index funds Learn more

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.

How to invest in index funds in the UK

Here’s a simply step-by-step guide explaining how you can start investing in index funds:

  1. Sign up for a provider. Check out our comparison table of platforms that offer funds to help you choose. You’ll need to provide personal details and proof of ID.
  2. Fund your account. You need to put money in your account in order to make investments. Transfer money into your trading account by bank transfer or using your debit card.
  3. Search for the index fund you want. You can often compare funds based on performance or browse the different ones available. Keep in mind, some platforms only offer exchange-traded funds (ETFs) which work in a very similar way.
  4. Place a buy order. That’s it. You can now invest on a regular basis or make one-off investments in the fund.
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What are 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.

How do index funds work?

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.

What's a stock market index?

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.

Example: Index funds explained

Take the HSBC FTSE 100 Index Fund. As of April 2023, it invests in 106 assets, made up of 96.94% in equities (company shares), with the remainder in cash, property, investment trusts and other assets.

The fund holds all of the companies that make up the FTSE 100 Index in similar proportions to which they are included in the index. Sometimes, it might not hold all of the companies. This would typically 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, as of the time of writing.

HSBC FTSE 100 Index Fund

  • Shell
  • AstraZeneca
  • HSBC Holdings
  • Unilever
  • BP
  • Diageo
  • British American Tobacco
  • Glencore
  • Rio Tinto
  • GlaxoSmithKline

FTSE 100 Index

  • AstraZeneca
  • Shell
  • HSBC Holdings
  • BP
  • Diageo
  • British American Tobacco
  • Rio Tinto
  • GlaxoSmithKline
  • Glencore
  • Unilever

As you can see, the top 10 stocks in the index fund are the same overall as the top 10 in the index itself, though the ranking is slightly diffferent.

The purpose of an index fund is to match the performance of the index, not beat it.

What index should I invest in?

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:

  • The FTSE 100 (UK). This includes the 100 largest companies on the London Stock Exchange by market cap. They’re mainly large, well-established companies such as Aviva and NatWest.
  • The FTSE All-Share (UK). This includes all the companies in the FTSE 100 and FTSE 250 (the next 250 biggest after the FTSE 100), plus companies on the dedicated ‘Small Cap’ index. It represents 98-99% of UK stocks by market capitalisation.
  • The Dow Jones (US). Or, to give it its full name, the The Dow Jones Industrial Average. It’s made up of the 30 most-traded stocks on the New York Stock Exchange and the Nasdaq, such as Apple and Disney.
  • The Nasdaq Composite (US). This tracks all 3,000+ stocks that are exclusively listed on the tech-heavy Nasdaq stock exchange, and includes Adobe, Microsoft and Netflix.
  • The S&P 500 (US). This comprises the 500 largest listed companies in the US, such as Apple, Amazon, and Tesla.
  • The Hang Seng (Hong Kong). This includes around 60 stocks from the Hong Kong Stock Exchange, one of the world’s biggest exchanges. Well-known names include Alibaba and Lenovo.

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.

Case study: Amy thought about dabbling in stock-picking but decided to invest in index funds instead

Amy Radcliffe profile pic
Amy Radcliffe

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.

What is the average index fund return?

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).

Are index funds safe?

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.

How much do index funds cost?

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:

  • An annual management charge. These can have various names like an “ongoing charges figure” (OCF) or “total expense ratio” (TER) and is made up from the costs of managing your index fund along with the internal transactions like buying or selling investments.
  • Commission. Unless you use a broker with zero trading commissions, you’ll usually have to pay a fee to cover the brokerage costs of making your index fund investment.
  • A platform fee. This doesn’t actually relate to the fund itself, but to invest in a fund you’ll need to use a broker or online investment platform. It will often (though not always) charge a fee for holding your investment account.

Are index funds good for those new to investing?

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.

Is now a good time to invest in index funds?

Danny Butler

Finder insurance expert Danny Butler answers

Timing the market is something that even experts struggle with, as it’s so hard to predict with any certainty what will happen next. Especially in a volatile economic environment, as has been the case in the UK in recent years (as of early 2023, at least).

The reality is that, provided you’re investing for the long term, there’s no bad time to start. The longer you have your money invested, the longer it has to ride out any volatility, grow, and help you meet your investment goals. Investing in index funds is no exception to this rule. And don’t be put off just because you’ve read news stories about the market being “down”. That just means that it should cost you less to buy investments that will hopefully rise in value when the market picks up.

Where to buy index funds in the UK

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:

Name Product Finder Score Min. initial deposit Price per trade Frequent trader rate Platform fees Offer Link
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OFFER
CMC Invest share dealing account
4.4
★★★★★
£0
£0
N/A
£0
Earn up to £1,000 when you transfer a minimum of £25,000 into your CMC account, plus get your first 3 months free when you upgrade to Plus plan. T&Cs apply. Capital at risk.
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Capital at risk

Platform details
XTB
4.4
★★★★★
£0
£0
£0
£0
Earn up to 5.2% interest on uninvested cash.
Go to site

Capital at risk

Platform details
InvestEngine
4.4
★★★★★
£100
£0
N/A
0% - 0.25%
Get a Welcome Bonus of up to £50 when you invest at least £100 with InvestEngine. T&Cs apply.
Go to site

Capital at risk

Platform details
Saxo Share Dealing Account
4.3
★★★★★
£0
£3
N/A
0.12% per year
Go to site

Capital at risk

Platform details
Finder Award
FREE TRADES
eToro Free Stocks
4.3
★★★★★
$100
£0 on stocks
N/A
£0
Go to site

Capital at risk. Other fees apply.

Platform details
Wealthify
4.2
★★★★★
£1
£0
N/A
0.6%
Go to site

Capital at risk

Platform details
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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.

Should I invest in index ETFs or index funds?

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:

  • ETFs are listed on stock exchanges. You buy and sell stakes in ETFs in the same way as shares.
  • They’re priced differently. The price you pay for an ETF can fluctuate throughout trading hours. Whereas, the price of an index fund is calculated once at the close of the trading day, when the net asset value (NAV) is assessed.
  • Fees and changes. You may not have to pay a commission for index funds, while you might with ETFs.

Learn more about the differences between index funds and ETFs

Why invest in an index fund?

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:

  • Index funds can be cheap. As they are passive, they don’t need as much legwork, which means they cost less than active funds.
  • Easy to trade. You don’t have to spend time buying and selling shares, saving you a bit of time.
  • They diversify your portfolio. This is a fancy way of saying that you get exposure to a range of different companies in one go.
  • Someone else does the work. Usually, people choose to go with index funds because they can pay someone else (aka the fund manager) to do the hard work. This is great if you’re a less experienced investor.

Infographic explaining how index funds work

What are the downsides of investing in index funds?

Despite their benefits, there are a couple of downsides of investing in index funds. In particular:

  • You’ll never beat the market. Index funds can only perform as well as the underlying index. Because there’s no active management, you have no chance of beating the returns of the index. That said, historic performance of passive vs active funds suggest the former typically fare at least as well as the latter, and often better.
  • You have no say over the specific stocks you invest in. You can’t pick and choose the stocks that are included by adding in companies that you like the look of, or removing any that you have an aversion to. For that, you’d need to invest directly in stocks.

Pros and cons of investing in index funds

Pros

  • Get exposure to a bundle of stocks with a single investment/li>
  • Often a cheap way to invest
  • Investing in passive index funds can be less time-consuming

Cons

  • You’ll never beat the market
  • You don’t get any choice or control of stocks in an index fund
  • Most index funds are market-cap weighted, so the bulk of your investment goes to the top stocks

Bottom line

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.

Frequently asked questions

Written by

George Sweeney, DipFA

George is a deputy editor at Finder. He has previously written for The Motley Fool UK, Nasdaq, Freetrade, Investing in the Web, MoneyMagpie, Online Mortgage Advisor, Wealth, and Compare Forex Brokers. He's focused on making personal finance and investing engaging for everyone. To do this he draws from previous work and his Level 4 Diploma for Financial Advisers (DipFA), sharing what he’s learnt. When he’s not geeking out about money, you’ll find him playing sports and staying active. See full profile

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2 Responses

    Default Gravatar
    gilbertFebruary 9, 2023

    Can an index fund be placed in an ISA?

      AvatarFinder
      LizFebruary 9, 2023Finder

      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).”

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