Index funds explained — the simplest way to invest in the UK

If you have ever been confused by investing jargon, index funds might be the answer. They are simple, low-cost, and backed by decades of evidence showing they outperform the majority of actively managed funds over the long term.

What is an index fund?

An index fund is a type of investment fund that tracks a specific stock market index — such as the FTSE 100, the S&P 500, or the MSCI World index — rather than trying to pick individual winning stocks.

When you invest in a FTSE 100 index fund, for example, you are effectively buying tiny slices of all 100 companies listed in the FTSE 100 in proportion to their size. If the FTSE 100 goes up 10%, your investment goes up roughly 10% too. If it falls 10%, your investment falls similarly.

Why are index funds so popular?

The case for index funds rests on two powerful arguments. First, most professional fund managers fail to beat the market consistently over the long term after their fees are taken into account. By simply tracking the market, an index fund delivers the market return minus a very small fee.

Second, index funds charge significantly lower annual fees than actively managed funds. A typical actively managed UK fund might charge 1% to 1.5% per year, while a comparable index fund might charge just 0.1% to 0.2%. Over decades, this difference in fees compounds into a very significant amount.

Which index should you track?

For most UK investors, a global index fund tracking thousands of companies across dozens of countries is a sensible starting point. The Vanguard FTSE All-World fund and the iShares MSCI World ETF are two popular options that provide broad global diversification in a single fund.

How to invest in index funds in the UK

The most tax-efficient way to invest is through a Stocks and Shares ISA, which shelters all growth and income from tax. Platforms such as Vanguard, Hargreaves Lansdown, Fidelity, and AJ Bell all offer index funds and ISAs with straightforward online applications.

Bottom line

Index funds are the simplest, cheapest, and most evidence-based way for most people to invest in the UK. Start with a low-cost global index fund inside a Stocks and Shares ISA, invest regularly, and let compounding do the work over time.