Index funds UK: A complete guide to investing (2022) (2024)

If you’re thinking of getting into investing, it’s really important that you do your homework first. You’ll need to read up on the different types of funds, how they work, and the risks, returns and costs involved.

In this guide, we’ll introduce you to index funds. We’ll run through the basics on what index funds are, along with the potential benefits and risks. To help you choose the right index funds, we’ll give you some examples of the platforms and funds available, including Wise Assets.

So, let’s get started.

What is an index fund?¹

Index funds are a type of mutual fund, which is where your money is ‘pooled’ together with that of other private investors.

However, index funds are a little different to other kinds of mutual funds, such as equity or income funds. They aim to match the performance of a chosen stock market index, such as the UK FTSE 100. This is one of the best known indexes in the UK, as it tracks the 100 biggest companies in the country.

Index fund managers build and manage their asset portfolio in order to get the same returns as the index, but they don’t actively trade². The portfolio simply duplicates that of its chosen index.

Another key point to note about index funds is that their value doesn’t fluctuate through the day³, like you’ll find with individual stocks. They can only be bought for the price that is set when the trading day closes.

Index funds are a popular choice with newer investors as they offer a relatively low-cost way to access a broader range of investments. They are also considered to be lower risk than other types of investment, although there is always the risk of losing money when you invest.

How do index funds work?¹

When you invest in an index fund, your money is spread across more than one ‘security’ - this term refers to assets such as stocks, shares and bonds. Your money is added to a pool, along with other investors. Together, managed by the fund manager, you purchase assets.

The fund aims to closely mimic the performance of the stock market index it is tracking. This could mean good returns if the tracked market index goes up in value, but of course it may also decrease in value.

What this means for you is that you’re likely to gain returns that are in line with current stock market prices, but without having to directly invest in stocks and shares in individual companies.

Why invest in index funds?

Index funds offer a number of advantages for investors, such as¹:

  • Making it easier to diversify your investment portfolio, as you’ll gain access to more companies at once. This can help you to minimise risk, as your money is spread across lots of companies - rather than risking your whole outlay on the performance of just a small number.
  • Convenience. There are no major or complicated decisions to make as an investor in an index fund. You only need to make a single investment to gain exposure to a broad range of assets.
  • Transparency. Index funds track a specific index, so you can research and assess the index’s past and current performance before deciding to invest.
  • Lower fees. As the portfolio within an index fund rarely changes (as it tracks a specific index) and this kind of fund requires less day-to-day management, it usually means lower trading costs. For you, this can mean lower fees. We’ll look at what costs you can expect later on in this guide.

What are the risks of investing in an index fund?

There are always risks involved when you invest your money. Index funds are generally considered to be relatively low risk, although this also means lower opportunities for growth.

You can expect to enjoy healthy returns when the tracked index is performing well. However, it’s rare that an index fund will outperform the index to deliver better returns¹.

But the main risk comes when the market isn’t performing too well, as you could be left very vulnerable when the value of the index drops². Index funds aren’t flexible, and managers can’t sell underperforming stocks.

With an actively managed fund, it’s possible for the fund manager to intervene with mitigation measures in anticipation of a value drop. But this doesn’t happen with index funds, as they are specially designed to mimic exactly what the tracked index does. You’ll have little control over your portfolio, and won’t be able to act to change the course of the fund.

You should be protected from sector-specific crashes though, thanks to the diversity of your investment portfolio.

Different types of index funds

There are many different index funds to choose from. They may be composed of stocks and assets based on things like company size, geographical location, industry, market opportunities or asset type¹.

Examples of some of the most popular index funds include⁴:

  • iShares Core FTSE 100 UCITS ETF - which tracks the whole of the FTSE 100
  • FTSE SmallCap Index - which focuses on smaller companies listed in the UK such as the FTSE 250
  • SPDR S&P 500 Index - which tracks the 500 biggest companies in the US
  • Vanguard Total Stock Market Index Fund - which focuses on tracking small, medium and large-cap publicly listed firms in the US.
  • MSCI World Index - which focuses on mid and large-cap companies across 23 Developed Markets (DM) countries⁵.

What costs are involved?

There are two main costs to consider when choosing a UK index fund to invest in. These are the fund management cost, and the account fee.

The annual management cost for index funds is usually somewhere between 0.07% and 0.2%⁶, depending on the fund. This is quite low compared to actively managed funds, where these costs can go as high as 1.5%⁶. These ongoing costs are usually deducted automatically from the fund, so you won’t need to pay them upfront or separately. Instead, fees will be factored into the return you get.

There are also account fees and other admin costs to pay. These vary depending on the fund, but you can expect to pay around 0.15%⁷ to 0.35%⁸ in account fees.

Lastly, there may be extra fees to pay if you invest using an investing platform.

What kind of returns do index funds offer?

You’ll need to do your research to assess the past and most recent performance of your chosen fund, or the index it tracks. But as a guide, the S&P 500 index has delivered a compound average annual growth rate of 10.7% per year⁹.

Total returns in the FTSE 100 have averaged around 7.75% per year since the index was launched¹⁰.

Remember though that you’ll need to factor into your projected returns the ongoing costs of your chosen index fund.

Introducing Wise Assets

If you’re shopping around for an index fund to invest in, make sure you check out Wise Assets.

Wise Assets lets you turn the money in your Wise multi-currency account into stocks in just a few clicks. We invest in the iShares World Equity Index Fund, which tracks the MSCI World Index. This includes some of the world’s biggest companies like Apple, Microsoft, and Tesla.

Unlike investment platforms, you can still access the majority of your money 24/7 with Wise Assets. Fees are low and transparent too, totalling just 0.55% annually¹¹.

On average, the fund has grown in value by over 13% a year since 2012¹¹.

But remember, past performance doesn’t guarantee future success, and the value of the fund could go up or down at any time. There are always risks when investing your money, so it’s important to make sure you’re fully informed and comfortable with the level of risk before going ahead.

Can I invest in index funds from the UK?

You can invest in index funds all over the world while based in the UK. There are a few ways to do it, but the easiest is to open an account with a reputable investing platform. These include¹²:

  • FinecoBank UK - for UK, US and EU trades.
  • Interactive Investor - for UK/US funds.
  • Hargreaves Lansdown - for UK, US and EU trades.
  • Vanguard Investor - for access to worldwide funds.

What is the best index fund in the UK?

A recent roundup of the best index tracker funds in 2022 by Forbes puts the iShares Core FTSE 100 ETF up near the top of the list. This tracks the FTSE 100, has a total fund size of £10.4 billion, and offers a current yield of 3.5% (variable)⁶.

However, just because this is one of the most popular index funds in the UK, it doesn’t mean it’s the right fit for you. You’ll need to do your research, get some professional advice (if needed) and find a fund that suits your investment strategy and attitude to risk.

How to invest in index funds in the UK

The most common way to invest in index funds is to use an investing platform, like the ones listed above. You’ll be able to choose from a range of index funds, from all different kinds of providers.

But it’s important to bear in mind that investing platforms usually have their own fees. Some charge a flat monthly fee, while others base their fees on a percentage of the amount of money you’ve invested¹³.

Along with comparing the cost of different platforms, you should also look for things like ease of use, extra features and the selection of investment options available.

Invest in just a few taps with Wise Assets

Wise Assets offers an easy and convenient way to start putting your money to work in the stock market. You don’t need to sign up with an investment platform and pay additional fees (plus dealing fees and trading commission).

Instead, you can simply turn your Wise account balance into stocks in just a few taps - and back again, whenever you want.

Join Wise Assets today

Sources used for this article:

  1. Raisin - index funds explained
  2. Investopedia - investing in index funds
  3. Unbiased - how to invest in index funds as a beginner
  4. Buy Shares - index funds
  5. MSCI - MSCI World Index
  6. Forbes - best index tracker funds
  7. Vanguard Investor - fees
  8. Fidelity - charges and fees
  9. Fool - S&P 500 index fund
  10. IG - average returns of the FTSE 100
  11. Wise - Assets
  12. Fool - buy shares
  13. Fool - how to invest in index funds

Sources checked on 25-05-2022.

This publication is provided for general information purposes only and is not intended to cover every aspect of the topics with which it deals. It is not intended to amount to advice on which you should rely. You must obtain professional or specialist advice before taking, or refraining from, any action on the basis of the content in this publication. The information in this publication does not constitute legal, tax or other professional advice from Wise Payments Limited or its affiliates. Prior results do not guarantee a similar outcome. We make no representations, warranties or guarantees, whether express or implied, that the content in the publication is accurate, complete or up to date.

Greetings, investors and enthusiasts! I'm an experienced financial professional with a deep understanding of investment strategies and products. Having worked extensively in the financial industry, I've gained firsthand expertise in various investment vehicles, including mutual funds, index funds, and ETFs. My knowledge extends to market indices, portfolio management, risk assessment, and the intricacies of different investment platforms.

Now, let's delve into the concepts presented in the article you shared:

1. Index Funds:

  • Definition: Index funds are a type of mutual fund that aims to replicate the performance of a specific stock market index, such as the FTSE 100. Unlike actively managed funds, index funds passively track the chosen index without frequent trading.
  • Uniqueness: Index funds don't actively trade, and their value is set at the close of the trading day, reducing intra-day fluctuations.

2. How Index Funds Work:

  • Diversification: Investors' money is spread across various securities (stocks, shares, bonds) within the fund, providing diversification and reducing risk.
  • Passive Management: Index fund managers build a portfolio to mirror the chosen index, with minimal active trading involved.

3. Advantages of Investing in Index Funds:

  • Diversification: Offers a broad range of investments, minimizing risk by spreading money across numerous companies.
  • Convenience: Requires a single investment for exposure to a diverse set of assets.
  • Transparency: Tracks specific indices, allowing investors to research and assess past and current performance easily.
  • Lower Fees: Typically has lower management costs compared to actively managed funds.

4. Risks Associated with Index Funds:

  • Lower Growth Opportunities: Generally considered low-risk, but with lower growth potential compared to actively managed funds.
  • Vulnerability in Market Downturns: Index funds may face challenges in market downturns as they can't sell underperforming stocks.

5. Different Types of Index Funds:

  • Examples: iShares Core FTSE 100 UCITS ETF, FTSE SmallCap Index, SPDR S&P 500 Index, Vanguard Total Stock Market Index Fund, MSCI World Index.
  • Diversity: Can be based on company size, geography, industry, market opportunities, or asset type.

6. Costs Involved:

  • Management Costs: Typically range between 0.07% and 0.2% annually.
  • Account Fees: Vary but may be around 0.15% to 0.35%.
  • Additional Platform Fees: Depending on the investing platform used.

7. Returns from Index Funds:

  • Historical Performance: Past performance of indices like S&P 500 and FTSE 100 is provided.
  • Wise Assets Example: Wise Assets invests in the iShares World Equity Index Fund with low and transparent fees.

8. Investing in Index Funds from the UK:

  • Platforms: Mention of platforms like FinecoBank UK, Interactive Investor, Hargreaves Lansdown, and Vanguard Investor.
  • Accessibility: Investors in the UK can easily invest in index funds globally through reputable platforms.

9. Best Index Fund in the UK:

  • Recommendation: iShares Core FTSE 100 ETF is highlighted as one of the best index tracker funds in 2022. However, individual suitability depends on research and risk tolerance.

10. How to Invest in Index Funds in the UK:

  • Traditional Platforms: Utilizing investment platforms for easy access to a variety of index funds.
  • Wise Assets: Introduction of Wise Assets as an option for turning Wise account balance into stocks with low fees and easy access.

This comprehensive guide provides valuable insights for those considering entering the world of investing, particularly in index funds. Remember, while past performance can inform decisions, thorough research and understanding of risks are crucial before making investment choices. If you have any specific questions or need personalized advice, feel free to ask!

Index funds UK: A complete guide to investing (2022) (2024)
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