If you’ve read anything about investing in the last decade, you’ve seen index funds mentioned. They’re the most frequently recommended investment vehicle for individual investors — and for good reason. They’re cheap, they work, and they require almost no expertise to use.
This article explains exactly what they are, how to buy them, and why most professional fund managers consistently fail to beat them.
What an index fund actually is
An index is a list of companies grouped by some rule — usually size or sector. The S&P 500 is a list of the 500 largest publicly traded companies in the US. The FTSE 100 is the 100 largest companies listed in the UK. The FTSE All-World covers over 4,000 companies across dozens of countries.
An index fund is a fund that owns all the companies in a given index in proportion to their size. When you buy a share of an S&P 500 index fund, you’re buying a tiny slice of all 500 companies at once — Apple, Microsoft, Amazon, and 497 others — in a single purchase.
The fund updates automatically when the index changes. If a company gets big enough to join the S&P 500, the fund buys it. If one shrinks out, the fund sells it. You don’t have to do anything.
Why index funds outperform most active managers
Active fund managers charge high fees to pick stocks they believe will outperform the market. The data on how well they do this is not flattering.
The SPIVA (S&P Indices Versus Active) report has tracked active versus passive performance for over two decades. Consistently, around 90% of actively managed funds in the US underperform their benchmark index over any 15-year period. In the UK, the numbers are similar — roughly 80–85% of active funds underperform their index over the long term.
Part of the reason is fees. An actively managed fund might charge 1–1.5% annually. A Vanguard S&P 500 index fund charges 0.03%. On a $50,000 investment growing at 7% annually, the difference in fees alone costs over $40,000 over 30 years.
The other part is that markets are remarkably efficient. Every professional investor is trying to find undervalued stocks. When millions of well-resourced analysts are all looking at the same information, it’s genuinely hard to consistently find something they’ve all missed. Most active managers don’t. Index funds stop trying and just own everything — which, over long periods, beats most alternatives. This is the same logic behind thinking long-term as an investor.
The main index funds to know
S&P 500 tracks the 500 largest US companies. It’s the most widely held index in the world and has returned an average of around 10% annually over the past century (7% after inflation). Most beginner portfolios are built around an S&P 500 fund or something very similar.
FTSE All-World covers over 4,000 companies across developed and emerging markets. It’s the most popular choice for UK investors who want global diversification rather than concentrating entirely in the US or UK markets.
FTSE 100 tracks the 100 largest companies on the London Stock Exchange. It’s heavily weighted toward financials and energy, which means it behaves differently from a global or US index and has historically underperformed both over long periods. Most UK investors use it for UK exposure rather than as their core holding.
Total Market funds (like the Vanguard Total Stock Market ETF in the US) cover the entire US market including mid-cap and small-cap companies, giving broader exposure than the S&P 500 alone.
ETFs vs index funds: what’s the difference
You’ll hear both terms used interchangeably, and for most purposes that’s fine. The practical difference is how they trade.
Traditional index funds (also called mutual funds) are priced once per day after the market closes. You buy and sell at the end-of-day price. ETFs (Exchange Traded Funds) trade throughout the day like individual stocks.
For long-term investors, this distinction barely matters. ETFs often have slightly lower minimum investments and can be easier to buy through a standard brokerage account. Both track the same indexes and offer similarly low fees. Most people starting out end up in ETFs simply because they’re easier to access.
How to actually buy index funds
In the US: Open a Roth IRA (if you’re under the income limit) or a standard brokerage account. Fidelity, Vanguard, and Schwab are the most commonly used platforms — all have zero-commission trades and strong selection of low-cost index funds. Search for FXAIX (Fidelity S&P 500), VOO (Vanguard S&P 500 ETF), or FSKAX (Fidelity Total Market) as starting points. If you’re unsure where to start, the investing in your 20s guide covers account setup step by step.
In the UK: Open a Stocks and Shares ISA to shelter your gains from capital gains tax and dividend tax. Vanguard UK, InvestEngine, and AJ Bell are popular platforms. The Vanguard FTSE Global All Cap or Vanguard LifeStrategy funds are commonly recommended starting points. InvestEngine offers commission-free ETF trading, which makes it particularly good for regular small contributions.
How much should you invest
More than you think you can afford, and starting earlier than feels necessary.
The maths of compound interest rewards starting early more than it rewards contributing large amounts later. Someone who invests £200 a month from age 22 ends up with significantly more at 65 than someone who invests £500 a month from age 35 — because of the decades the earlier investments have to compound. The compound interest guide goes through those numbers in detail.
A rough starting framework: once you have a basic emergency fund in place, aim to invest 10–20% of your take-home income in index funds monthly. Start at whatever you can genuinely sustain, then increase it each time your income rises.
Mistakes index fund investors make
Checking too often. Index funds are designed to be held for decades, not months. Investors who check their portfolios daily are more likely to panic sell during dips — which is the surest way to underperform the index over time. Check quarterly at most.
Switching when it drops. Market downturns feel like losses. They’re not — they’re discounts on future growth, assuming you hold long enough for the market to recover. Every major crash in history has been followed by a recovery to new highs. Selling in a downturn locks in losses permanently.
Overcomplicating it. Owning 15 different funds doesn’t diversify you — it just adds complexity. One global index fund is genuinely all most people need to start. Add more only when you have a specific reason.
Ignoring fees. A 0.1% annual fee is very different from a 1% annual fee over 30 years. Before buying any fund, check its expense ratio. Look for funds under 0.2% — anything higher needs a strong justification.
The boring truth about index fund investing
Index funds work not because they’re clever, but because they’re consistent. You buy regularly, you don’t sell when prices drop, and you let the market do its job over decades.
Most people who try to do better than a simple index fund — by picking individual stocks, timing the market, or chasing last year’s best-performing fund — end up doing worse. The evidence on this is overwhelming and has been consistent for decades.
You don’t need to understand the market deeply to invest in it well. You just need a regular contribution, a low-cost global index fund, and the discipline to leave it alone. Build the contribution into your monthly budget before it has a chance to become spending, and let time do the rest.