Are you looking for ways to invest your money? If yes, then you should definitely consider investing in index funds. These are mutual funds that track a particular benchmark or index. They are considered low risk because they don’t try to beat the market. Instead, they simply follow the performance of a certain index.
Index funds are widely regarded as the safest way to invest your money. They’re also very cost effective. In fact, they’re often cheaper than actively managed funds. Throughout this post we will explore exactly what index funds are, some examples of popular index funds and how to choose an index fund that is right for you.
What Exactly are Index Funds?
An index fund is a type of mutual fund that tracks an index. An index is basically a group of securities from the stock market that represent a specific industry sector such as technology stocks, energy companies, etc. The index fund will buy all the shares in the relevant sectors within the index and hold them over time. This means that when the index rises, so does the value of the fund. When it falls, the fund values fall too.
One good way to imagine an index fund is that it is like a basket of stocks and instead of having to worry about buying all of the stocks individually, you can buy the basket and get a little bit of everything. Index funds are a very common investment strategy due to how easy it is to go down this route.
Try not to get index funds mixed up with a standard mutual fund. They are both similar however there are some important differences. Most importantly mutual funds often are ran by fund managers and can contain any stocks at the choice of the fund manager whereas index funds specifically focus on certain index's. This is why index funds can also be referred to as index tracker funds.
The Advantages of Index Funds
- Index tracker funds have are a good investment decision due to the diversification benefits. Diversification is a term to describe when your investments are diverse across multiple assets. This is achieved by the index fund containing a little bit of lots of stocks. The benefit comes from the fact that if one stock goes down then it doesn't take your entire portfolio with it.
- Much easier to manage as less investment decisions are required. Due to the index fund being a general sector as opposed to individual companies, you can spend a lot less time research and analysis companies balance sheets, financial reports etc. This is why index fund investing is considered one of the easiest forms of investing. Just put the money in and ride the waves!
The Disadvantages of Index Funds
- You likely won't get crazy returns. Just as the diversified portfolio prevents your position from crashing if one companies value goes down in the index fund. It also prevents you from getting outsized returns that an individual asset could give. Often the returns through an index fund are somewhat slow but more consistent hence less risk, less reward.
- Another disadvantage of investing in index tracker funds is that you have no control of the assets in the index fund. Of course you get to select the fund you purchase but let's say there is a fund you really like but a couple of companies in the fund that you don't like; well you'll have to just accept that they are included or go about buying all of the other stocks in the fund individually.
Our Favourite Index Funds
As our site is mainly focused at UK investors we will list our favourite index tracker funds available to UK investors.
1. iShares Core FTSE 100 UCITS ETF (ISF)
This fund tracks the performance of the FTSE 100 Index. The index comprises the 100 largest companies listed on the London Stock Exchange. This is a good choice if you want to focus on the big players within the UK market. As the name implies, this index contains 100 holdings providing an average annual return of 6.49% for the previous 10 years.
2. Vanguard FTSE 250 UCITS ETF (VMID)
This fund tracks the FTSE All-Share Index which is a broad measure of the equity market consisting of 250 large, mid-cap and small cap stocks traded in the United Kingdom. The fund offers a low expense ratio of 0.10% per year. In addition to offering a low expense ratio, the fund also offers a high level of transparency. You can see exactly what each company is worth and even check out their latest earnings report.
3. S&P 500 UCITS ETF (VUSA)
The S&P 500 Index is designed to provide exposure to the total U.S. market. It consists of 500 widely held common stocks representing approximately 85 percent of the market capitalization of all U.S. corporations. Vanguard allows UK investors to get involved with their S&P500 (VUSA) ETF. With ongoing charges of 0.07% this is another great pick for a broad investment strategy.
Factor in Ongoing Costs
Make sure when deciding on your ETF, you consider the ongoing costs. The main cost associated with index funds as mentioned are the ongoing charges. The ongoing charges are usually based off a yearly calculation of your overall portfolio. However, there are sometimes additional charges in relation to the individual purchases.
Even small charges can have large impacts over time due to the power of compound interest. According to which.co.uk the following ongoing charges are to be expected depending on the type of fund you are looking at
- 0.75% to 1.25% in most actively managed funds.
- 0.1% to 0.85% in most passively managed 'tracker' funds
- 0.8% to 1.8% in most investment trusts
The reason index funds have a much lower ongoing fee is due to them being a passive fund. This passive fund means that no person (or people) have to
Invest via Your Chosen Platform
There are of course many more index funds available then the few I have listed however, regardless of the index fund, you must ensure you can actually purchase said fund. The funds we have mentioned in this post are all available through the main investing app I use, Freetrade.
Freetrade also offers many other index funds from Vanguard and iShares. If you would like to check out some of the funds or even purchase the funds mentioned in this post then you can sign up to Freetrade with the link below.
Pick Funds that Reflect your Investing Strategy
When picking an index fund it is important to understand how they work. Each fund has its own unique approach to generating returns. Some may invest in smaller companies while others will invest in larger ones. There are also different types of funds such as growth stock funds, value stock funds and income funds.
It's best to choose one that matches your needs. For example, if you're looking to build wealth then a growth fund might be right for you. If you're looking to reduce risk then a value fund could be a better option.
Index funds offer diversification by tracking a particular index. They do not attempt to beat the market but rather aim to match the performance of the benchmark. By doing so they allow you to benefit from the gains
Summary
Index funds are a popular choice among investors because they provide a low-cost way to gain exposure to the broader markets. These funds track indexes and therefore give you access to the entire market without having to worry about selecting specific sectors or companies.
They are easy to buy and hold and offer a good level of diversification. As long as you stick to them you should see consistent results.
If you want to learn more about investing in general then you can read my article on How To Start Investing for Beginners.
Thanks for Reading 😊
FAQ
Why invest in Tracker funds?
Instead of having a manager who tries to pick investments to beat the markets, tracker funds – also known as passive or index funds – simply follow the overall performance of a particular market or index, such as the FTSE 100. (barclays.co.uk)
What is an index fund/exchange traded fund?
Index funds and ETFs are types of mutual funds that allow you to invest your money in more than one security (‘securities' is a blanket term for the range of assets that includes stocks & shares and also bonds). Indexes measure the price of a so-called ‘basket of securities' (anything that has interchangeable value) and can either have a specific focus or measure performance across a broad range of markets and sectors. The index fund aims to match the market performance of its index as closely as possible. (unbiased.co.uk)
Why are tracker funds also called 'index' funds?
There is at least one index for each stock market. For example, the FTSE 100 is an index that represents the biggest 100 UK companies, and the FTSE All-Share represents all the UK companies listed on the London Stock Exchange. More obscure indices, made up of bonds or commodities, also exist and can be accessed by investors. (which.co.uk)
What should I consider when choosing an index fund?
The main factors you need to consider when investing in an index fund are how much risk you’re comfortable with, the fees you’re willing to pay and the length of time you’re willing to invest your money for. Deciding on these factors can help you determine if an index fund is for you. (raisin.co.uk)