Looking for a straightforward way to invest in the stock market? Investing using an index fund can be a great option. Especially, if you don’t like the idea of researching and picking all your own stocks and shares.
We’ve created this comprehensive guide to explain how to invest in index funds. We’ll also cover all the details UK investors should know about this type of investment. This Includes how they work, the costs, and where to find the best platforms to invest in index funds.
How to invest in index funds
The process can be straightforward. Here’s a quick step-by-step guide for investing in index funds:
Find a brokerage: not all online brokers in the UK will offer index-tracking funds. It’s important to find a trading platform with index funds or ETFs, and ideally make sure it’s easy and cheap to invest.
Choose the index fund: after setting yourself up with an investment account, select the fund (or funds) you want to buy.
Decide how much to invest: once you’ve found your online brokerage and picked your index fund, think about how much you want to invest and how frequently. You can invest in index funds with a lump sum or set up a regular payment.
Buy shares in the index fund: the last step involves purchasing your chosen index fund with money you’ve set aside for investing.
What is a stock market index?
This is a measure or benchmark used to track multiple stocks. A stock market index can give you a snapshot of a market or industry, making it easier to track the performance.
Examples of popular indices
Here are some examples of popular stock market indices:
FTSE 100: the 100 largest companies on the London Stock Exchange (LSE)
FTSE 250: the 250 largest companies on the LSE
S&P 500: contains 500 of the largest US stocks
Nasdaq 100: made up of 100 tech stocks listed on the Nasdaq stock exchange
Nikkei 225: for the 225 largest-listed Japanese stocks
What are index funds?
This is a type of investment that tracks the performance of an index. Most ETFs (exchange-traded funds) also use an index as a benchmark, as do some mutual funds.
Index fund investing only became popular over the last few decades. It was first introduced as a passive investing method by Jack Bogle, founder of Vanguard.
It’s been a successful investing strategy over the years, beating many active investors. Because of this, more index funds and index-tracking ETFs have become available.
The goal is to mirror the index or market that the fund is named after. For example, a FTSE 100 index fund would copy the index, meaning the fund invests in every single company in that index.
How do they work?
Index funds hold various stocks and shares based on whatever index is used as the benchmark. The two main ways the funds are organised are usually:
Market capitalization weighting: this is the most popular. It means companies with a bigger market cap hold a bigger position in the index. So, when you invest, more of your money goes to the top companies.
Equal weighting: this is less common. It means that each company in the index has equal weighting. So if you were to invest, the same amount of money would go to each stock in the fund.
Index funds usually operate automatically (for the most part) with little human involvement. Successful stocks join the index (and the fund), and unsuccessful stocks are removed from the index (and the fund). You can think of them as self-cleansing.
This simplicity also means that most index funds come with lower fees than actively managed investment funds. By definition, an index fund aims to match the performance of a market (rather than beat it).
The difference between an index fund and an ETF
Although most ETFs operate like index funds, there are some key differences:
| Index funds | ETFs |
|---|---|
| Can only be priced and traded once a day | Can be priced and traded throughout market trading hours |
| Usually need to be bought direct from the index fund management company | Can be bought on multiple exchanges and various online brokerages |
| Management fees can be slightly higher | Management fees can be slightly lower (but often, a commission needs to be paid to your broker) |
| Choice can be limited | Much greater choice of fund options |
Benefits and drawbacks of investing in index tracker funds
Below is a breakdown of the major advantages and disadvantages you should consider if you want to invest in index funds.
Index fund benefits
Key benefits include:
Diversification: investing in an index fund exposes you to a whole group of stocks, giving you some extra diversity.
Cheap: most index funds or ETFs tracking major markets have low fees.
Reliable: investing returns are never guaranteed. But, investing in a broad market tracker fund gives you a great chance of building long-term wealth.
Index fund drawbacks
Key drawbacks include:
Performance: because most index funds track market performance, you’ll never beat the market or see outsized returns.
Lack of control: you don’t get to decide what stocks make up an index. So you might end up investing in companies that you don’t want in your portfolio (or missing out on stocks that you do want).
Weighting: market-cap weighting means the bulk of your investment goes to the top stocks. So, you’ll be mainly investing in companies that have already had an explosive growth phase.
Finding the best platform to invest in funds
When you’re looking for the best place to invest in index funds, there are some crucial points to look out for:
Choice of funds: it’s important to pick an investing platform with the particular index fund or ETF you want to invest in.
Fees: most passive index funds are cheap. You don’t want to cancel this out by paying high commissions or brokerage fees.
Mobile app: many UK investors prefer to use a mobile app when investing and managing their portfolios.
Robo-advisor: some platforms will build a portfolio using a combination of funds.
Best platforms for investing in ETFs and index funds
Below are three of the best trading platforms for UK investors looking to primarily invest in index funds.
Vanguard
Vanguard created the modern idea of index fund investing. So, Vanguard is a great pick if you want to buy index funds straight from the source.
It costs nothing to open a general investment account (GIA) or stocks and shares ISA with Vanguard. On top of this, the platform has low accounts fees and fund costs, charged on a percentage basis.
Currently, the Vanguard account fee is 0.15% (capped at £375/year), and you’ll also pay varying ongoing fees based on the fund you choose.
So, the more you invest in a Vanguard index fund, the more you’ll pay in fees. But this makes the platform ideal for those with smaller portfolios.
There are a few downsides to Vanguard. There’s no mobile app and your choices are limited to the Vanguard range of index funds and ETFs. Also, you need a £500 lump sum or £100 per month to get started.
InvestEngine
InvestEngine is a useful low-cost online brokerage. One that’s excellent for investing in index-tracking ETFs.
With InvestEngine, you can build your own ETF portfolio. Or use its robo-advisor service to manage a portfolio of funds for you.
With the DIY service, it costs nothing to open and hold an account. There are also no fees for buying ETFs or opening a stocks and shares ISA. You only pay for the ongoing charges linked to the fund.
If you want the robo-advisor service, you pay a flat 0.25% management fee (on top of fund fees).
This makes InvestEngine one of the cheapest ways to invest in over 500 ETFs. You can start investing in index funds with just £1, which is useful if you’re just starting to invest. And, InvestEngine has a top app that’s highly rated on both the App Store and Google Play.
Hargreaves Lansdown
Although Hargreaves Lansdown (HL) can be expensive for some investors, it’s good value if you’re looking to invest in funds.
HL offers free fund trading. So there are no commissions to pay. Also, there’s no upfront cost to hold an account. You just pay an ongoing percentage based on the size of your portfolio (ranging from 0.45% to free).
This account fee also includes the use of a stocks and shares ISA. On top of this, HL has a whopping choice of over 3,000 funds.
There are also plenty of resources to help you out, like:
Shortlists
Popular index funds lists
Responsible fund screeners
Ready-made investment funds
Although HL is a great platform for index fund investing, it’s quite expensive if you want to buy other types of investments.
How much do index tracker funds cost?
It depends on the index fund. Most funds will display charges as either:
TER (total expense ratio)
OCF (ongoing costs)
The cost will usually be shown as a percentage and can range from 0.03% to almost 1% with some providers.
If you’re using an index fund that tracks a major market (like the FTSE 100 or S&P 500), it’s worth picking one with the lowest fees.
The investments will be almost identical. So there’s no point paying more for a particular fund (unless your brokerage has limited choices).
Always double-check the fund costs and any additional costs from your share dealing platform.
Choosing the right fund for your strategy
Finding the right index fund will depend on your goals.
If you’re hoping for lots of growth and have faith in technology stocks, you might want to look at something like a Nasdaq 100 fund (e.g. Invesco EQQQ NASDAQ-100 UCITS ETF)
Or, if you’re more conservative and want to use dividend payments to compound your investments, a FTSE 100 index fund may be more suitable (e.g. iShares Core FTSE 100 UCITS ETF).
The point is, each index is built differently. Think about your investing time horizon, risk appetite, and overall goals.
Always dig into each fund before you buy, and make sure it aligns with the rest of your investment portfolio.
You get some diversity with index funds, but remember you might be concentrating on just one region or sector.
What’s the best index fund to invest in?
It’s impossible to say. And it depends on how you define ‘best’. The best performing index funds over the last few years may not do so well over the coming years. Because, the economy and market conditions change over time.
One alternative is to look at the most popular index funds in the UK. These aren’t necessarily the best index funds, but they give you some insight into the funds investors are buying.
Typically, it’s best to go for broad-market ETFs that track the best companies within a country. Or a global equity index fund that invests in top companies from all over the world.
There are also other things to think about other than performance. Perhaps you might want to pick a socially responsible or ESG index fund to invest in. Or use an index fund that pays out a dividend.
Popular index funds and ETFs in the UK
Here’s a list of the 10 most popular investment funds during 2022, according to interactive investor:
Fundsmith Equity
Vanguard LifeStrategy 80% Equity
Vanguard LifeStrategy 100% Equity
Vanguard LifeStrategy 60% Equity
Vanguard US Equity Index
Vanguard FTSE Global All Cap Index
L&G Global Technology Index Trust
Vanguard FTSE Developed World ex-UK Equity Index
Vanguard FTSE UK Equity Income Index
Fidelity Index World
The bottom line on index fund investing in the UK
Index fund investing is a top strategy to use for most types of investors. And learning how to invest in index funds doesn’t take long.
It’s still worth taking some time to find the right fund or ETF. And then, pick a platform that best suits your needs.
Once you choose a brokerage and a fund, investing in an index fund is pretty straightforward.
Index fund investing may not be the most exciting. But, it’s a popular and efficient way for beginners and experienced UK investors to build wealth in the stock market.
