When you invest in an index fund, you have the opportunity to access shares in a diverse range of companies at once for a relatively low cost.
Remember, the value of investments can go down as well as up, and you may not get back what you invest.
What are the features of investing in index funds?
An index measures the combined performance of a collection of assets. For example, the FTSE 100 is an index of the 100 largest UK companies by market capitalisation on the London Stock Exchange. The S&P 500 index contains 500 of the largest companies by market capitalisation in the US.
You can’t invest directly in an index, but you can invest in an index fund.
An index fund will typically buy shares, and try to maintain this, in every company listed on the index it’s tracking. So, the FTSE 100 index fund might buy a certain number of shares in all 100 companies to fully replicate and mirror the performance of the FTSE 100.
Alternatively, index funds can partially replicate the index, where a sample of shares are held to represent the overall index.
If the index goes up by 1%, the value of your investment in the index fund will typically go up by 1%. Similarly, if the performance of the index falls by 1%, so should the value of your investment in the index fund. There are other factors which may affect value but the general idea is to replicate the actual index as far as possible.
There are hundreds of indexes you can invest in through index funds.
When you invest in index funds, you can gain exposure to a broad range of investments, which can help spread risk compared to a direct investment in each asset. This is because any loss on one particular investment within the index is more likely to be balanced by a gain somewhere else.
Investing in multiple index funds could help spread risk further. For example, you could invest in funds that track the performance of:
Funds can be a good option for investors of all experience levels, but especially if you’re new to investing, as you don’t have to pick individual stocks (eg shares or bonds).
When it comes to index funds, depending on the management style, the fund manager may not actively select companies to invest in, as they’re aiming to mirror, rather than beat the performance of an index. This is why they’re sometimes known as ‘passively managed’ funds.
Passively managed funds tend to have lower fees than actively managed funds, where the fund manager picks stocks to meet the fund’s objectives.
You’ll still need to pay some fees to invest in an index fund, including an annual management charge.
Index funds are not immune to market volatility, and the value of your investments can fall as well as rise. If the FTSE 100 dips, the index fund tracking it also dips.
Investing should be seen as a medium to long-term commitment, which means you should be prepared to invest for at least 5 years to give your money a chance to grow.
Ideally, build an emergency fund of 3 to 6 months' worth of living expenses before investing. This safety net can prevent you from having to sell your investments too early.
You can’t pick and choose the stocks contained within an index fund. You either take it or leave it.
But you have control of what index fund you invest in and the level of risk you feel comfortable with.
Some index funds could be dominated by a particular sector (for example, technology or financial services), rather than having an even weighting across different sectors. This could affect the value of your investments if that sector were to experience losses.
Choosing diversified, or multiple, index funds could help minimise this risk.
Index funds typically pay dividends if the underlying companies they invest in pay them.
You may be able to choose between ‘income’ or ‘accumulation’ when investing in an index fund. The ‘income’ option may suit you if you’re looking for regular income, although, like all investments, there are no guarantees.
‘Accumulation’ means the fund reinvests dividends on behalf of investors – buying additional shares with the aim of growing the value of your investment.
Investing in index funds can be a simple way to get started with investing.
We offer a wide range of index funds on our online platform, the Global Investment Centre and Sharedealing
If you're looking for a particular fund, you can use our fund directory.
Or, if you open a Global Investment Centre account, you can use our handy research tool to compare up to 5 funds at a time to help you decide.
There are also a range of index ETFs on our online share dealing platform, InvestDirect.
Eligibility criteria and some fees apply.
