What an index fund is
An index is a list of companies, chosen by a rule such as size. An index fund (or an index ETF, which trades like a share) simply buys them all, in proportion to their size. Nobody picks winners, so it’s cheap to run.
The indexes UK investors meet most:
| Index | What it holds |
|---|---|
| FTSE 100 | The 100 largest companies listed in London |
| FTSE All-Share | Most of the UK stock market, large and small companies |
| FTSE All-World or MSCI World | Large and mid-sized companies across the world (MSCI World: developed markets only) |
A UK-only fund puts all your money in one fairly small market, where a few sectors, such as banks, oil, mining and drug makers, make up a large share. A global index fund spreads it across the world, including the UK.
UK funds come as OEICs or unit trusts, priced once a day, or ETFs, traded through the day. Look for “Acc” (accumulation) units if you want dividends reinvested for you, or “Inc” (income) units if you want them paid out.
Why it usually wins
- You get the market’s return. Some companies soar and some fail, but you own all of them.
- It’s spread out. One company going bust barely moves an index fund.
- It’s cheap. Index funds often charge 0.1% to 0.3% a year. Actively managed funds often charge 1% or more.
- Most stock pickers fall behind. Studies of fund performance, such as S&P’s SPIVA reports, find that most actively managed funds do worse than their index over 10 to 15 years.
What fees cost you
£10,000 invested for 30 years, growing 7% a year before fees:
| Yearly fee | After 30 years |
|---|---|
| 0.1% | £74,017 |
| 1% | £57,435 |
| Difference | £16,582 |
The fee comes out every year, and so do the returns it would have earned. In the UK you usually pay two fees: the fund’s ongoing charge and the platform fee of the company you invest through. Some platforms charge a percentage of your money, others a flat fee, which can work out cheaper once your pot is larger. The compound interest calculator shows growth with your own figures.
Over 30 years, a 1% fee costs you
£16,582
- You keep (1% fee)£57,435
- Lost to the higher fee£16,582
Assumes a 7% return every year before fees. Real returns vary, but fees come out every year.
Picking your own stocks
It can be fun, and some people do well, but:
- A few stocks are risky: one bad result can wipe out years of gains.
- Trading costs add up. You pay a dealing charge on many platforms, and 0.5% stamp duty on most purchases of UK shares. ETFs are exempt from it.
- Tax applies outside an ISA or pension: dividends over £500 a year and gains over £3,000 are taxed.
- It’s hard to tell skill from luck over a few years.
If you want to try, keep it to a small share of your money, and the rest in index funds.
How to start
- Use a tax-free wrapper: a Stocks and Shares ISA (up to £20,000 a year across your ISAs), a Lifetime ISA if you’re saving for a first home, or your pension. See where to invest.
- Choose a global index fund or ETF. Check the ongoing charge and the platform fee: together they should be well under 1% a year.
- Use an FCA-authorised platform. If it fails, the FSCS protects your investments up to £85,000, though not against markets falling.
- Set up a monthly payment and leave it alone.
Invest money you won’t need for at least 5 years, and keep going when markets fall: selling in a panic turns a temporary fall into a real loss. Start with investing basics if you’re new.