Index funds and ETFs explained: the simplest way to invest (UK)
What index funds and ETFs are, how they differ, why low fees matter, global vs UK funds, accumulation vs income, and how to choose one for your ISA or pension.
In this guideShowHide
What is an index?
An index is a list of companies that represents a market. Examples:
- FTSE 100: the 100 largest companies on the London Stock Exchange
- S&P 500: about 500 large US companies
- Global indices: thousands of companies across developed and emerging markets
An index fund simply holds the companies in its index, in the same proportions.
Index funds vs ETFs
Both track an index. The difference is how you buy them:
| Index fund (OEIC or unit trust) | ETF (exchange-traded fund) | |
|---|---|---|
| How you buy | From the fund, once a day at a set price | On the stock exchange, any time it is open |
| Minimum | Often small regular amounts | One share, or fractions on some apps |
| Dealing costs | Often free on platforms | Some platforms charge per trade |
| Best for | Regular monthly investing | Apps with free ETF trading |
For most beginners the choice comes down to what is cheapest on your platform.
Why low costs matter
Index funds and ETFs often charge 0.1% to 0.3% a year. Actively managed funds, where a manager picks shares, often charge 0.75% or more, and many fail to beat their index after fees.
Over decades the difference compounds. See it for yourself in the compound interest calculator by changing the fee.
Global or UK?
- Global funds spread your money across thousands of companies in many countries. If one country struggles, others may not.
- UK-only funds put everything in one market, which is a small part of the global economy.
- US funds have done very well in recent years, but put a lot in one country and a few large tech companies.
Many investors use a global fund as their core and add others only if they have a clear reason.
Accumulation or income?
- Accumulation (Acc): dividends are reinvested automatically. Best if you are building wealth.
- Income (Inc): dividends are paid out to you as cash. Useful if you want an income.
How to choose an index fund
- What does it track? A broad global index is the simplest core holding.
- Ongoing charge: lower is better, all else equal.
- Size and track record: bigger, established funds tend to track their index closely.
- Accumulation or income: match it to whether you want growth or income.
- Inside an ISA or pension: so you pay no tax on the growth.
The risks
Index funds rise and fall with the market. A global fund can drop 20% or more in a bad year. They spread your risk across companies, not away from the stock market itself. Only invest money you can leave for at least five years.
Common questions
Are index funds good for beginners?
They are widely recommended for beginners because they are low cost, diversified and do not depend on choosing individual shares.
Is an ETF the same as an index fund?
Most ETFs track an index, so they work in a similar way. The main difference is that ETFs trade on the stock exchange like shares.
How much do I need to start investing in an index fund?
Many platforms let you invest from £1 to £25 a month in index funds or fractional ETFs.
This is general information, not personal tax or financial advice. Tax rules change and depend on your circumstances, so check GOV.UK or speak to an accountant before acting.