What is an index fund?
What you'll learn
Understand what an index fund is and why its low cost matters so much.
An index fund lets you own a tiny slice of an entire market in one cheap purchase. Instead of betting on individual companies, it simply tracks an index - a list of companies, like the largest firms in a country.
How it works
An index fund holds (or closely mirrors) every company in its index. If the index has 500 companies, your money is spread across all 500. No manager is paid to pick winners; the fund just follows the list. That is why it is passive and why it is cheap.
| Index fund | Active fund | |
|---|---|---|
| Goal | Match the market | Beat the market |
| Run by | A simple rule | A manager picking stocks |
| Typical cost | Low | Higher |
| Spread of holdings | Wide | Varies |
Why low cost matters
Fees look tiny but they compound against you. The chart shows the same pot growing identically before costs: the lower-fee version ends well ahead purely because less was skimmed each year. Over a working life, the gap can be tens of thousands of pounds.
Low cost is the one advantage you can lock in from day one. You cannot control the market, but you can control what you pay to access it.
Key takeaways
- An index fund tracks a whole market rather than picking stocks.
- It spreads your money widely, cutting single-company risk.
- It is passive, so it is usually very low cost.
- Small annual fees compound over decades; keeping them low keeps more of your money.
Illustrative only: assumes the same growth before fees and shows how a higher annual fee drags the end value down over decades. Figures are made up to show the effect. Not a forecast.
Frequently asked questions
Is an index fund the same as an ETF?
An index fund can be a traditional fund or an ETF; both can track an index. The ETF simply trades on an exchange like a share.
Are index funds safe?
They spread your money across a whole market, which lowers single-company risk, but the overall value can still rise and fall.
How does an index fund keep costs low?
There is no manager hand-picking stocks. It simply mirrors the index, so there is far less to pay for.
General information, not financial advice. The value of investments can fall as well as rise, and figures and rules can change; check the current position before acting.