What is an index?
An index is a list of assets used to measure the performance of a market. The S&P 500 is a list of the 500 largest companies on US stock exchanges. The FTSE 100 is the 100 largest companies listed in London. The MSCI World covers roughly 1,500 companies across 23 developed countries.
Indexes don't exist as things you can buy. They're measurement tools. When people say "the market went up 1.2% today," they mean an index moved by that amount.
How an index fund works
A fund pools money from many investors and buys assets. An index fund specifically buys the assets that make up a particular index, in the same proportions. A fund tracking the S&P 500 buys shares in all 500 companies. When Apple's weighting increases, the fund buys more Apple.
You buy units in the fund. The value rises and falls with the collective performance of the underlying companies. You own a tiny slice of 500 businesses at once.
Index funds don't try to beat the market. They try to match it. That sounds like settling. It turns out to be an advantage.
Why passive investing usually beats active
Active fund managers try to pick stocks that will outperform. They have research teams, Bloomberg terminals, decades of experience. Over a 15-year period, around 88% of them underperform a simple index fund.
Not because they're bad at their jobs. Markets are efficient, the price of any stock already reflects what millions of informed people think it's worth. To consistently know better than the whole market, year after year, is genuinely difficult.
Types of index fund
- S&P 500, 500 largest US companies. High US concentration but historically strong returns. What we invest in.
- FTSE All-World, roughly 4,000 companies across developed and emerging markets.
- MSCI World, ~1,500 companies across 23 developed markets. No emerging markets.
- FTSE 100, 100 largest UK-listed companies. Not recommended as a sole holding for beginners.
ETF vs index fund
An ETF (Exchange Traded Fund) trades on a stock exchange like a share. Most index funds available to UK retail investors are structured as ETFs. The terms are often used interchangeably, the structure (ETF) and the strategy (index tracking) are two different things that usually go together.
How to buy one in the UK
You need an investment account first, for most people a Stocks and Shares ISA. Our full ISA guide covers how to open one and choose a platform. Once your account is funded, search for the fund by name or ticker. The Vanguard S&P 500 UCITS ETF trades as VUSA on the London Stock Exchange.
Understanding the costs
Index funds charge an Ongoing Charges Figure (OCF). A 0.07% OCF means you pay 70p per year for every £1,000 invested. You may also pay a platform fee, typically 0.15–0.25% per year. Both are significantly lower than active fund alternatives.
Module 5 covers index funds, active funds and ETFs in plain English, including the specific fund we use and why we chose it. Three modules free, no card needed.
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