Index funds have emerged as an economical and straightforward investment option, rewarding many investors with substantial returns in recent years. Unlike actively managed funds, where a fund manager selects stocks or other assets to outperform the market, an index tracker fund simply mirrors the market’s performance.
Investors have various options, from funds that track the expansive global stock market to those focused on a specific country’s market or a curated collection of assets.
It’s essential, however, for the index a fund tracks to be well-defined, with investments being made and adjusted through a computerized, rules-based approach.
This approach is referred to as passive investing, in contrast to active investing, where decisions are driven by a fund manager’s selections.
Passive funds aim to mirror every component of their tracked index, striving to match its performance exactly. Such funds won’t outperform the market, but they also avoid underperformance due to unsuccessful investment decisions.
The cost benefits are significant as well. While an active global fund manager might charge around 0.7% annually on your investments, an index fund typically costs much less, often under 0.2%.
Beat the market: Index funds are a cheap and easy way to invest that have made some investors a lot of money in recent years
Index funds surged in popularity in the 1990s when firms began widely offering them to small investors – although they had been used for decades by large professional investors. The trend has accelerated through the past decade, with the Investment Company Factbook 2025 showing 51 per cent of assets in long-term US funds were now held in index tracking funds.
The popularity of index funds has been fuelled by strong gains from the US stock market, which in turn makes up 72 per cent of the global stock market, as measured by the MSCI World Index.
A British investor holding Vanguard’s S&P 500 index fund, which tracks the US’s leading stock market index, would have made a total return of 83 per cent over the past five years.
And holding Fidelity’s Index World fund, which tracks the MSCI World Index, would have made 92 per cent.
But while index funds may be popular and can be very cheap, not all are made equal.
Some carry higher charges, despite doing the same thing as their rivals, and others may have a propensity for returns that differ more from their set index than alternatives.
Index funds come in two main forms – investment funds and exchange-traded funds (ETFs).
Index investment funds are bought and sold by investors in units, which will rise or fall in value with the value of the assets that the fund holds. They are priced once a day.
ETFs, which have ballooned in popularity in recent years, are traded on the stock market and bought and sold in the same way as individual company shares.
They are priced continuously throughout the trading day and have an ‘ask’ price for buyers and a ‘bid’ price for sellers. The gap between them is known as the bid-ask spread, and a narrow difference between the two indicates high demand.
Despite their differences, index tracking funds and ETFs work in a similar way, and choosing between the two is a matter of personal choice.
This may come down to your DIY investing platform and its fees – read our guide to investment platform fees at thisismoney.co.uk/platforms. And always watch out for fund costs – there is little point in deciding to invest through index funds and then opting for one that carries high fees.
Another thing to watch out for is ‘tracking error’ – where a tracker fails to accurately follow the index.
The difference is usually small but can become wider over longer timespans. So always compare the fund’s performance to the index it follows and look for data on tracking error on your investment platform.
Here are some index fund and ETF options
UK stock market
Index fund: HSBC FTSE All-Share Index, ongoing charges 0.07%
ETF: iShares Core FTSE 100 Fund, ongoing charges 0.07%
US stock market
Index fund: Legal & General US Index, ongoing charges 0.1%
ETF: Vanguard S&P 500, ongoing charges 0.07%
Global stock market
Index fund: Fidelity Index World, ongoing charges 0.12%
ETF: Vanguard FTSE All World, ongoing charges 0.19%
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