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How to Invest in Index Funds in the UK

How to Invest in Index Funds in the UK

How to Invest in Index Funds in the UK

How to Invest in Index Funds in the UK

Wondering how to invest in index funds in the UK? I’ve got you covered.

I’ll fill you in on the simplicity and effectiveness of index funds, and explain how this passive investment approach can help you achieve your financial goals in the long term.

What Is an Index Fund?

An index fund is a type of mutual fund or exchange-traded fund (ETF) that aims to replicate the performance of a specific market index.

It achieves this by investing in a diversified portfolio of assets, such as stocks or bonds, that mirrors the composition and weighting of the target index.

Index funds are designed to passively track the overall market’s performance rather than attempting to outperform it actively.

Due to their low fees and simplicity, index funds have become a popular choice for long-term investors seeking broad market exposure and consistent returns.

One example of an index fund in the UK is the “Vanguard FTSE 100 Index Unit Trust.”

This fund aims to replicate the performance of the FTSE 100 Index, which represents the 100 largest companies listed on the London Stock Exchange by market capitalisation.

By investing in this index fund, investors gain exposure to a diversified portfolio of leading UK companies, providing a simple and cost-effective way to participate in the growth of the UK stock market.

How Do Index Funds Work?

Index funds work by passively tracking the performance of a specific market index.

Here’s a step-by-step explanation of how they operate:

  1. Index Selection: The fund manager chooses a particular market index to replicate, such as the S&P 500, FTSE 100, or a bond index. The index represents a predefined group of stocks, bonds, or other assets that collectively reflect a specific segment of the financial market.
  2. Portfolio Construction: The index fund constructs a portfolio of assets that closely mirrors the composition and weighting of the selected index. For example, if the index consists of 500 stocks, the fund will hold a representative selection of those 500 stocks in the same proportion as the index.
  3. Passive Management: Unlike actively managed funds, index funds do not rely on a fund manager’s expertise to make frequent buying or selling decisions. Instead, they aim to replicate the index’s performance by holding the same assets as the index, maintaining a “buy and hold” strategy.
  4. Rebalancing: Periodically, the fund will rebalance its holdings to match any changes in the index’s composition. This ensures that the fund remains in line with the index it tracks.
  5. Low Fees: Index funds typically have lower management fees compared to actively managed funds. This is because they require less active management and trading, leading to cost savings for investors.
  6. Diversification: By investing in an index fund, investors gain exposure to a diverse range of assets within the index, reducing individual company or sector risk. This diversification can be a key benefit of index funds.
  7. Market Returns: The performance of an index fund will closely follow the performance of the underlying index, minus any fees or expenses. As the index rises or falls, the value of the index fund’s shares will do the same.

Overall, index funds offer a straightforward and efficient way for investors to gain exposure to a broad market or specific asset class while seeking to match the market’s returns over the long term.

This passive approach has proven to be an effective strategy for many investors looking to build wealth steadily over time.

Index Funds vs Actively Managed Funds

Index funds and actively managed funds differ in their investment approach and management style.

Index funds aim to replicate the performance of a specific market index passively.

They do not rely on active stock picking or market timing and instead hold a diversified portfolio of assets that mirror the index’s composition.

As a result, index funds typically have lower fees, offer broad market exposure, and tend to perform in line with the market they track.

On the other hand, actively managed funds employ a hands-on approach where a fund manager selects and trades individual securities with the goal of outperforming the market or a benchmark index.

However, actively managed funds often come with higher fees due to the active management involved.

Despite the potential for outperformance, research has shown that the majority of actively managed funds fail to consistently beat their benchmark indices over the long term.

Consequently, many investors opt for index funds as a reliable, cost-effective, and less risky way to invest for the long term.

Index Funds vs ETFs

Index funds and exchange-traded funds (ETFs) share many similarities, as both are investment vehicles designed to track the performance of a specific market index.

However, there are some key differences between the two:

  • Structure: Index funds are mutual funds, which means they are priced and traded once per day at the fund’s net asset value (NAV) after the market closes. In contrast, ETFs are traded on stock exchanges throughout the trading day like individual stocks, and their prices may fluctuate in real-time due to supply and demand.
  • Trading Flexibility: ETFs offer greater trading flexibility than index funds because investors can buy and sell them at any time during market hours at market prices. Index funds, on the other hand, can only be traded once per day at the closing NAV price.
  • Fees: In general, ETFs tend to have lower expense ratios compared to traditional index mutual funds. This is partly because ETFs typically require lower operational costs due to their structure.
  • Investment Minimums: Some index mutual funds may have minimum investment requirements, whereas ETFs have no such minimums. Investors can buy even a single share of an ETF.
  • Dividends: Index mutual funds often distribute dividends to shareholders periodically, while ETFs may distribute dividends more frequently, such as quarterly.
  • Tax Efficiency: ETFs are generally more tax-efficient than index mutual funds, mainly due to the way they are structured. ETFs allow for in-kind redemptions, which can help reduce capital gains tax liabilities.

Both index funds and ETFs are popular investment choices for those seeking market exposure and diversification.

The decision between the two often comes down to individual preferences, trading habits, and specific investment goals.

How to Invest in Index Funds in the UK: Step-By-Step

To buy index funds in the UK, follow these step-by-step instructions:

Step 1: Research and Choose a Brokerage Platform

Research and select a reputable brokerage platform that offers access to a wide range of index funds. Look for platforms that have low fees, user-friendly interfaces, and good customer service.

Step 2: Open an Account

Sign up for an account on the chosen brokerage platform. This typically involves providing personal information, verifying your identity, and agreeing to the platform’s terms and conditions.

Step 3: Fund Your Account

Deposit money into your brokerage account using a bank transfer or other accepted funding methods. Make sure you have enough funds to cover the initial investment amount and any subsequent investments.

Step 4: Conduct Research

Research various index funds available on the platform. Look for funds that match your investment goals, risk tolerance, and time horizon. Consider factors such as the fund’s expense ratio, historical performance, and the index it tracks.

Step 5: Select the Index Fund

Choose the index fund you want to invest in based on your research. Ensure it aligns with your investment strategy and offers exposure to the market or asset class you desire.

Step 6: Determine Investment Amount

Decide on the amount you want to invest in the index fund. Some funds may have minimum investment requirements, so verify that your chosen amount meets the fund’s criteria.

Step 7: Place the Order

On your brokerage platform, find the specific index fund you wish to purchase and place a buy order. Enter the investment amount and review the details before confirming the order.

Step 8: Monitor Your Investment

After purchasing the index fund, regularly monitor its performance and review your investment strategy. Consider setting up automatic contributions to the fund to keep investing regularly and take advantage of potential long-term growth.

Where to Buy Index Funds in the UK?

In the UK, you can buy index funds through various financial institutions and investment platforms.

Here are some common options:

  1. Online Brokerage Platforms: Many online brokerage platforms offer access to a wide range of index funds. Some popular platforms in the UK include Hargreaves Lansdown, AJ Bell Youinvest, Interactive Investor, and Fidelity.
  2. Banks: Some major banks in the UK may also offer their customers the option to invest in index funds through their investment or wealth management services.
  3. Robo-Advisors: Robo-advisors are automated investment platforms that create and manage a diversified portfolio for you based on your risk tolerance and investment goals. They often include index funds in their portfolio offerings. Examples of UK robo-advisors include Nutmeg, Moneyfarm, and Wealthify.
  4. Fund Management Companies: Many well-known fund management companies, such as Vanguard, BlackRock (iShares), Legal & General, and others, offer their own index funds that you can purchase directly through their websites or through other investment platforms.
  5. Workplace Pension Schemes: If you have a workplace pension, it may include index funds as part of its investment options. Check with your employer or pension provider for more information.

Before selecting a platform or provider to buy index funds, compare their fees, services, investment options, and customer reviews to find the one that best suits your needs and preferences.

Additionally, ensure that the platform is regulated by the Financial Conduct Authority (FCA) to ensure your investments are protected.

How to Select an Index Fund?

To select an index fund, start by defining your investment objectives and risk tolerance.

Determine whether you want exposure to a specific market segment or a broad market index.

Next, research different index funds that align with your goals and track the index you’re interested in.

Compare key factors such as expense ratios, historical performance, fund size, and the assets held within the fund.

Lower expense ratios are preferable, as they can impact your overall returns.

Look for funds with a solid track record of closely tracking their respective indices.

Additionally, consider the fund’s diversification and the companies or assets it holds.

If possible, opt for funds with a larger number of holdings to reduce individual company risk.

Lastly, choose a reputable fund provider with a strong track record and a good reputation for customer service.

How to Use ISAs and SIPPs When Investing in Index Funds?

Using ISAs (Individual Savings Accounts) and SIPPs (Self-Invested Personal Pensions) can be advantageous when investing in index funds in the UK.

Here’s how you can utilise both tax-efficient accounts:

  1. ISAs:
    • Contribution Limit: Each tax year, you can invest up to a certain amount in an ISA (the annual ISA allowance). The current allowance is £20,000 per individual.
    • Tax Benefits: Any gains or income generated within an ISA are tax-free. This means that you don’t have to pay capital gains tax on profits or income tax on dividends or interest earned from your index fund investments.
    • Investment Flexibility: You can use your ISA to invest in a variety of assets, including index funds. Choose a platform that offers a selection of index funds that align with your investment goals and risk tolerance.
    • Long-Term Savings: ISAs are an excellent tool for building tax-efficient long-term savings, making them a popular choice for retirement planning and other financial goals.
  2. SIPPs:
    • Tax Relief: SIPPs offer tax relief on contributions. When you contribute to your SIPP, the government adds basic rate tax relief, boosting your investment. Higher-rate taxpayers can claim additional tax relief through their tax returns.
    • Investment Options: Similar to ISAs, SIPPs provide a wide range of investment options, including index funds. You can tailor your SIPP portfolio to include various index funds to create a diversified retirement savings strategy.
    • Long-Term Retirement Planning: SIPPs are designed specifically for retirement savings. The funds within your SIPP grow tax-free, providing a tax-efficient way to build a nest egg for your retirement.

To utilise ISAs and SIPPs effectively when investing in index funds, it’s essential to consider your investment horizon, risk tolerance, and overall financial goals.

Both accounts offer valuable tax advantages, allowing you to maximise your investment returns over the long term.

Why Invest in Index Funds?

Investing in index funds offers numerous compelling benefits that make them an attractive choice for both seasoned and novice investors.

First and foremost, index funds provide broad market exposure, allowing investors to diversify their portfolios across various companies, industries, or asset classes with a single investment.

Their passive management approach ensures lower fees compared to actively managed funds, potentially leading to higher long-term returns.

As index funds aim to track specific market indices, they eliminate the need for extensive research and stock picking, making investing more straightforward and less time-consuming.

Additionally, historical data consistently shows that many actively managed funds struggle to outperform their respective benchmarks, making index funds a reliable option for consistent market returns.

Whether you’re a hands-on investor or seeking a long-term wealth-building strategy, index funds provide a simple, cost-effective, and time-tested way to participate in the financial markets.

Pros & Cons of Index Funds


  • Diversification: Index funds offer instant diversification across a wide range of assets or companies, reducing individual investment risk.
  • Low Fees: With their passive management approach, index funds typically have lower expense ratios compared to actively managed funds, allowing investors to keep more of their returns.
  • Consistent Returns: Index funds aim to replicate the performance of the market or a specific index, providing investors with steady and predictable returns over the long term.
  • Simplicity: Index funds are easy to understand and invest in, making them ideal for beginners or investors who prefer a hands-off approach.
  • Tax Efficiency: Due to minimal trading within the fund, index funds tend to be more tax-efficient, leading to potential tax savings for investors.


  • Limited Upside Potential: While index funds provide consistent returns, they also limit the potential for substantial outperformance compared to actively managed funds, which can take advantage of market opportunities.
  • Market Risk: As index funds track the market, they are still subject to market volatility and downturns, which can result in temporary losses.
  • No Outperformance Guarantee: Index funds aim to match the performance of the underlying index, but they do not guarantee outperformance compared to the market or other investment strategies.
  • Lack of Customisation: Investors cannot customise the holdings of index funds, as they are predetermined by the index they track, limiting flexibility in tailoring investments to individual preferences.

Final Thoughts

Investing in index funds is a powerful and accessible strategy for UK investors seeking to build long-term wealth.

With their low fees, broad market exposure, and consistent returns, index funds offer a simple and effective way to participate in the financial markets.

By understanding your investment goals, risk tolerance, and conducting thorough research, you can make informed choices and embark on a journey towards financial success with index funds.


Are index funds safe?

Index funds are generally considered a safe investment option. They provide broad market exposure, diversification, and follow a passive investment strategy. While all investments carry some level of risk, index funds are designed to track the performance of a specific market index, spreading risk across various assets or companies. As a result, index funds tend to be less volatile than individual stocks and have historically offered steady and consistent returns over the long term. However, it’s essential for investors to understand that market fluctuations can still affect index fund values. As with any investment, risk tolerance, investment goals, and time horizon should be considered before making investment decisions.

Are index funds good for those new to investing?

Index funds can be an excellent choice for those new to investing. They offer simplicity, diversification, and low fees, making them a straightforward and cost-effective way to get started in the financial markets. Index funds eliminate the need for individual stock picking and extensive market research, making investing more accessible to beginners. With index funds, investors can gain exposure to a broad range of assets or companies with a single investment, reducing risk compared to investing in individual stocks. Additionally, their passive management approach helps new investors avoid the complexity of actively managing their portfolios. Overall, index funds provide a reliable and beginner-friendly option to start building wealth and achieving long-term financial goals.

What is the easiest way to invest in index funds UK?

The easiest way to invest in index funds in the UK is through online brokerage platforms or investment apps. These platforms offer a user-friendly interface, making it simple to open an account, deposit funds, and browse a wide selection of index funds. Investors can easily research and compare different funds, select the ones that match their investment goals, and make investments with just a few clicks. Many of these platforms provide educational resources and tools to help beginners get started and make informed investment decisions. With low fees and hassle-free transactions, investing in index funds through online platforms is a convenient and accessible option for anyone looking to begin their journey in the financial markets.

Are index funds better than stocks?

Whether index funds are better than individual stocks depends on an investor’s goals, risk tolerance, and investment strategy. Index funds offer benefits like diversification, low fees, and simplicity, making them an attractive choice for many investors seeking broad market exposure. They can be less risky than investing in individual stocks since they spread investments across multiple assets or companies. However, stocks provide the potential for higher returns if the right individual companies are chosen. Stocks require more research and active management, while index funds track the market passively. Ultimately, the best choice depends on an individual’s preferences and whether they prioritise simplicity and long-term growth (index funds) or seek potentially higher returns with more active involvement (stocks). Some investors may choose a combination of both to balance risk and reward.

Are index funds tax-free in the UK?

In the UK, index funds are not inherently tax-free. However, they can be held within tax-efficient accounts like Individual Savings Accounts (ISAs) or Self-Invested Personal Pensions (SIPPs) to benefit from certain tax advantages. Within these accounts, any gains or income generated from index funds are typically tax-free. Outside of tax-efficient accounts, index funds may be subject to taxes on capital gains and dividends. It’s essential to consider the tax implications based on the specific investment account you use and consult with a tax professional for personalised advice.

What are ethical stock market indexes?

Ethical stock market indexes are benchmarks that focus on including companies with positive environmental, social, and governance (ESG) practices. These indexes allow investors to align their investments with their values and support sustainable and responsible businesses. By investing in these indexes, individuals can potentially make a positive impact while seeking financial returns.

How to invest in the S&P 500 from the UK?

To invest in the S&P 500 from the UK, you can use online brokerage platforms that offer access to US markets. Open an account, deposit funds, and search for an S&P 500 index fund or ETF available on the platform. Ensure the fund tracks the S&P 500 and has a low expense ratio. Place a buy order for the chosen fund, and you’ll be investing in the performance of the S&P 500 companies, gaining exposure to the US market from the UK. Read my full guide on how to invest in the S&P 500 from the UK from.

What is the best index fund in the UK?

There is no single “best” index fund in the UK, as the ideal choice depends on individual preferences, risk tolerance, and investment goals. Popular options include funds tracking the FTSE 100, FTSE All-Share, or global indices like the MSCI World. Key factors to consider are expense ratios, historical performance, and the fund’s alignment with your investment strategy. It’s essential to research and compare various index funds to find the one that suits your needs and objectives. Consulting with a financial advisor can provide personalised guidance for selecting the most suitable index fund for you.

How much should you invest in an index fund?

The amount to invest in an index fund varies based on individual financial circumstances, goals, and risk tolerance. Start with an amount you feel comfortable committing, and consider regular contributions to benefit from compounding. Aim to maintain a diversified portfolio across various assets to manage risk.

Is the S&P 500 index fund a good investment?

The S&P 500 index fund is generally considered a good investment for long-term growth. It provides exposure to a diversified portfolio of 500 large US companies, representing a significant portion of the US stock market. The S&P 500 historically has shown strong returns over time, making it a popular choice for investors seeking consistent market performance. However, like all investments, it’s essential to consider your risk tolerance and investment goals before deciding if the S&P 500 index fund aligns with your overall financial strategy. Diversifying your portfolio across various assets is recommended to manage risk effectively.

Do UK index funds pay dividends?

Yes, UK index funds may pay dividends. Many index funds include companies that distribute dividends to their shareholders. When investing in an index fund that tracks a dividend-paying index, investors may receive a portion of the dividends based on their holdings in the fund. However, not all UK index funds focus on dividend-paying companies, so it’s essential to check the fund’s specific investment strategy and holdings to determine if it pays dividends.

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I’m Will! I recently left my job working for one of the UK’s leading financial companies in London to start Sterling Savvy, a place to empower people in the UK financially.


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