What is an index fund?
An index fund is a fund designed to track a market index rather than trying to beat it. Instead of a manager selecting investments they think will outperform, the fund simply holds everything in the index — automatically, at low cost.
What an index is
An index is a list of investments that meets certain criteria. The FTSE 100, for example, is an index of the 100 largest companies listed on the London Stock Exchange. The S&P 500 is an index of 500 large US companies. The MSCI World index covers around 1,500 large and mid-cap companies across 23 developed countries.
An index fund does not pick from these lists — it holds all of them, in proportion to their size. When a company grows and its weight in the index increases, the fund automatically holds more of it. When a company is removed from the index, the fund sells it.
Why the passive approach has become so widely used
The case for index investing rests on evidence accumulated over decades. Studies consistently show that the majority of actively managed funds — where a manager picks stocks in an attempt to beat the market — underperform their benchmark index over 10 to 20 year periods, once fees are taken into account.
This is not because active managers are incompetent. Markets are highly competitive, and the collective effort of millions of informed participants makes consistent outperformance extremely difficult to sustain. An index fund sidesteps this competition entirely: it does not try to win. It simply owns the market.
The fee advantage
Index funds typically charge between 0.05% and 0.25% per year. Many active funds charge 0.75% to 1.5% or more. That difference compounds significantly over decades. On a £50,000 portfolio over 20 years at 7% gross return, the difference between a 0.15% fee and a 0.75% fee amounts to roughly £17,000 in lost returns. The fund that simply tracked the market kept it.
What index funds do not do
An index fund does not protect you from market falls. If the index drops 30%, your fund drops roughly 30% too. Passive investing is not the same as safe investing — it simply removes the additional drag of fees and the risk of manager underperformance. You still bear the underlying market risk, which is why your time horizon and risk comfort matter.
Index funds vs ETFs
These terms are often used interchangeably, but they are not identical. An ETF is a structure — it trades on an exchange. An index fund is a strategy — it tracks an index. Many ETFs are index funds. Some index funds are not ETFs (they are priced daily like traditional funds). For most beginners, the practical difference is minor; what matters more is the index being tracked and the cost.
Use the fee impact calculator to see exactly how much the difference between a 0.15% and 0.75% annual charge costs you over your investing horizon.