Index Funds and ETFs Explained for UK Beginners

If you have ever felt that investing means picking the next big company, you will be relieved to hear it does not have to. Many everyday investors use index funds and ETFs, which spread your money across hundreds or even thousands of companies in one go.

What is an index fund?

An index is simply a list of companies used to measure the market, such as the FTSE 100 (the 100 largest companies listed in London) or a global index covering companies around the world. An index fund copies that list. When you buy it, your money is automatically divided between all the companies in the index, in proportion to their size.

Because the fund simply follows the list rather than paying a manager to pick winners, the charges are usually much lower than for actively managed funds. Lower charges matter, because over many years they can make a real difference to what you end up with.

What is an ETF?

An ETF (exchange-traded fund) is very similar, but it is bought and sold on the stock market throughout the day, like a share. Many ETFs also track an index. In practice, the main difference is how you buy them: index funds are usually bought at a price set once a day, whereas ETFs trade whenever the market is open.

Why people like them

• Diversification. You are not relying on one company to do well.
• Low cost. Ongoing charges are often a fraction of those on actively managed funds.
• Simplicity. You can build a sensible portfolio with just one or two funds.

What to check before you buy

• The ongoing charge. Look for a low figure, and remember platform fees are separate.
• What it tracks. A global fund is more spread out than one tracking a single country.
• Accumulation or income. Accumulation funds automatically reinvest any dividends, while income funds pay them out to you.

A worked example

Ben invests £100 a month into a global index fund inside a Stocks & Shares ISA. He does not choose individual companies, he does not time the market, and he does not check the price daily. Over the years his money is spread across thousands of businesses, and any growth is sheltered from tax. If one company struggles, it barely dents the whole.

The honest caveat

Index funds and ETFs can still fall in value, sometimes sharply, and you can get back less than you put in. They are generally best for money you will not need for at least five years. Our guide to [choosing an investment platform](/blog/how-to-choose-an-investment-platform-uk) explains where to buy them.

Action step

Decide how long you could leave the money untouched. If it is five years or more, read up on low-cost global index funds and compare the charges on two or three platforms.

This article is for general information only and doesn't constitute financial advice. The value of investments can go down as well as up, and you may get back less than you invest. Consider speaking to a regulated financial adviser before making major decisions.