What is an index fund?

Also known as a tracker fund, an index fund is a type of investment that mirrors the performance of a financial market index. For example, the UK FTSE 100, or US S&P 500.

Index funds are a type of passive investing. They’re usually easy to set up and manage, with relatively low fees, making them popular with new and long-term investors alike.

How does an index fund work?

An index fund works by mirroring the performance of an index. Instead of trying to beat the market, an index fund aims to match the return of a benchmark stock index.

For example, say you have a FTSE 100 index fund. If the FTSE 100 goes up by 5%, the value of your investment in your index fund should also increase by the same amount.

Similarly, if the index goes down by 5%, the value of your investment would usually also fall by the same percentage.

Index funds can be either:

  • Mutual funds – these set their price at the end of each day of trading.
  • Exchange-traded funds (ETFs) – values change throughout the day in line with share prices.

What is an index fund?

Also known as a tracker fund, an index fund is a type of investment that mirrors the performance of a financial market index. For example, the UK FTSE 100, or US S&P 500.

Index funds are a type of passive investing. They’re usually easy to set up and manage, with relatively low fees, making them popular with new and long-term investors alike.

 

How does an index fund work?

An index fund works by mirroring the performance of an index. Instead of trying to beat the market, an index fund aims to match the return of a benchmark stock index.

For example, say you have a FTSE 100 index fund. If the FTSE 100 goes up by 5%, the value of your investment in your index fund should also increase by the same amount.

Similarly, if the index goes down by 5%, the value of your investment would usually also fall by the same percentage.

Index funds can be either:

  • Mutual funds – these set their price at the end of each day of trading.
  • Exchange-traded funds (ETFs) – values change throughout the day in line with share prices.

Is investing in an index fund worth it?

Whether an index fund is right for you depends on what you want to achieve. Here are some of the key benefits and considerations.

Benefits of investing in index funds

  • Lower fees – index funds are a form of passive investment. This means a fund manager won’t pick and choose what to invest in, saving you on these fees.
  • Minimal effort – you can generally invest and sit back – well suited to those short of time. 
  • Beginner-friendly – most index funds are put together by experts. You won’t need to worry about which specific assets to invest in.
  • Less risk – you spread your money across a range of investments. This could protect against dips in a specific market or asset. But it’s still important you understand the risk before investing.

Things to consider before investing in index funds

  • Limited flexibility – you can’t choose what stocks are in the fund. It tracks and sticks to a specific index, which means it might be less flexible for you.
  • Market dependency – index funds’ performance depend on the market they track. If something causes that whole market to dip, indexes tracking it will also usually go down.
  • Some funds have higher-risk stocks – while index funds tend to be lower risk, some track riskier stocks. As always, it’s important to do your research and understand all the potential risks.
  • Modest results – index funds see market-average returns. Make sure you can afford to leave your investment for the long term and be comfortable with gentler rises or falls in value.

Choosing an index fund that’s right for you

When considering which index fund to invest in, ask yourself a few questions:

What market is the fund located in?

Index funds can focus on stocks that trade in the UK, the US, global markets, or a combination. This will affect the fund’s performance, how diversified it is and the level of risk.

How many companies are in the fund?

Index funds generally track hundreds of companies but can track thousands or just a few dozen. Larger or smaller funds can both have their pros and cons.

What is the index fund tracking?

Index funds can track all sorts of things – government bonds, companies of a certain size or market cap, stocks in the same industry, or even commodities such as gold.

How to invest in index funds

 

1. Choose an index to track

There are many different types of index funds, so choose wisely and do your research. You could compare these based on performance.

2. Transfer some money

You’ll need to pay in money once your investment account is open.

3. Place a buy order

Once you know which index you want to track, place a buy order with your broker or trading platform.

Steps to take

We’ll guide you through it.

Please remember that the value of investments and the income from them can fall as well as rise, and you may get back less than you invest. If you’re not sure about investing, seek financial advice. There will normally be a charge for this. Tax treatment depends on individual circumstances and current UK tax rules.

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