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You might hear plenty of investing experts bang on about index funds and what a great investment they can be. But they tend to overlook the basics and don’t explain what an index fund is.
So, to help you on your investing journey, this epic guide covers everything you need to know about this type of investment. You’ll learn all about what these funds invest in, how they work, and – whether you can make money by using them.
Keep reading for all the essential details or click a link below to jump straight to a specific section…
Don’t be put off by the fancy-sounding name, it’s basically a list. The word ‘index’ refers to categorising something into a group. In this case – investments.
An index allows us to measure a group of investments in a simple and straightforward way.
Some common examples of indexes you may have come across (or heard journalists screaming about on the news) include:
These indices are just long lists containing some of the biggest and best companies in the UK and the US.
But, an index can track all sorts of things. There are actually over three million stock market indices across the globe!
Each one tracks the performance of a group of assets. This is why investment funds that follow or copy an index are sometimes called ‘tracker funds’.
This is a single investment that tracks the performance of all the assets within that particular index.
When the index average goes up – or down – your share value does the same. This varies every day as the markets change.
So, if you wanted to invest in the top 100 companies in the UK, the easiest way is to invest in a FTSE 100 index fund.
This is because, instead of making individual investments into each of the one hundred companies – you can own a piece of each business with a single investment, using an index fund that tracks the FTSE 100.
Index funds are also usually ‘market-cap weighted’. This sounds super fancy. But, all it means is that the biggest companies in the index fund receive a larger portion of your investment.
So, in practice, if you were to invest £100 into a FTSE 100 index fund:
Investing into an index fund does limit your choice and investment control.
Because you’re investing into the whole index, you don’t get to pick and choose which shares you want to invest in.
This market-cap weighting can make these investments a little ‘top-heavy’. But, your money is often safer invested with the larger firms because smaller companies can be riskier.
Here’s a breakdown of some of the unique advantages you’ll get when investing this way:
No way of investing is bulletproof, and there are always downsides to consider. Here’s a few of the potential pitfalls of investing this way:
The biggest difference is that you can find ETFs (exchange-traded funds) on stock exchanges and multiple investing platforms. This means that ETFs can be bought and sold throughout the day, based on live prices – just like stocks or shares. Whereas an index fund usually has a set price determined at the end of each day.
When you’re investing over the long-term, this won’t make much of an impact. The various names of investments can create a lot of confusion. But, for all intents and purposes, you can think of most ETFs as index funds.
Sometimes you’ll also find that you can only buy certain index funds direct through a platform, but the ETF version can be found with multiple brokerages.
For example, some Vanguard index funds can only be bought with a direct account. But, you can usually buy shares in an ETF version of the same fund somewhere like eToro or Freetrade.
Yes! Although, it depends on which fund you choose to invest in.
Over the long-run, it’s been proven time and again that index funds often outperform actively managed funds. And, they’re cheaper – which means you get to keep more of your returns, instead of paying them out in fees to a greedy fund manager!
Past performance doesn’t dictate future results, but index funds have provided excellent returns to patient investors:
You might wonder why people even bother to invest in something like the FTSE 100 instead of the S&P 500, well here’s why:
So, when investing, it’s not all about which index funds have grown the most in the past. You should find the trackers that suit your goals and style of investing.
Unfortunately, there’s no ‘one-size-fits-all’ answer. The best index fund for you will depend on your goals, your investing strategy, and your tolerance for risk.
The options you can access through your brokerage platform may also limit your choices.
That being said, here are some tips for finding excellent index funds:
The right fund for you will be specific to your own goals and circumstances. But, to give you some inspiration, here are some of the most popular index funds and ETFs for UK investors:
The process will vary depending on the platform you use, but here are some simple steps for buying an index fund:
If you don’t have an investing account set up already, you can do so with reputable brokers such as:
When it comes to investing, this isn’t your only option. Here are some alternative ways to invest:
Whatever type of investor you want to be, you have loads of choice these days! Index funds are a great place to start investing and you can always adjust your strategy as you learn more about the markets.
You can also keep up to date with the latest investing news and insights by signing up to our fortnightly Investing Newsletter!
This is not financial or investment advice. Remember to do your own research and speak to a professional advisor before parting with any money.