A Beginner's Guide to
Index Funds and ETFs
Before we get into it, a quick disclaimer: this post is for educational purposes only and isn't intended as financial advice. Always do your own research, and remember your capital is at risk when investing because the value of your investments can go down as well as up.
What's in this guide:
Introduction
If you've spent any time on my channels, you'll know I talk about index funds and ETFs pretty much every single week.
It may seem like I'm obsessed with them, and I think I might be a little bit. But that's because they're genuinely, in my opinion, one of the best inventions in the history of the stock market, especially for everyday investors like you or me.
But I still get questions like these in my comments and DMs all the time:
- What's actually the difference between an index fund and an ETF?
- Are they the same thing?
- Is one better than the other?
I'm going to break it all down for you here, nice and simply. Hopefully, by the end of the blog, you'll have the answers to all these questions!
So What Actually IS an Index Fund?
Let's start from scratch. The stock market is made up of thousands of individual companies, listed on exchanges all over the world. In reality, it's as simple as opening an app like Trading 212*, typing in "Apple", and within minutes you can own a slice of it.
An index fund is simply a basket of companies: think the tub of Celebrations rather than just the Maltesers, or chucking everything on your plate from an all-you-can-eat buffet rather than just the chicken nuggets.
You've probably heard people talking about the FTSE 100 (which tracks the UK's 100 largest companies) or the S&P 500 (which does the same, but for the US's top 500), and maybe even seen them ticking away at the bottom of your screen where stock market information sits.
The S&P 500 alone represents around 80% of the total value of the entire US stock market, according to S&P Dow Jones Indices, the very company that runs it.
So if you wanted to invest in the S&P 500, you could, in theory, buy shares of each of the 500 companies in it.
But, and this is a big but: the top 500 companies in the US are always changing, and that's exactly where funds, and index funds specifically, come in.
Since the S&P 500 launched in 1957, fewer than 90 of the original 500 companies remain in the index today. The rest have merged, gone bankrupt, or simply been overtaken by bigger, newer companies.
An index fund is something you can invest in that simply tracks the performance of one of these indexes.
It doesn't have to be the FTSE 100 or the S&P 500, there are loads of indexes out there to choose from, and we'll have a look at some of the most popular down below.
Index funds are created by investment companies to represent a particular index as best as possible. This means you can buy into a single fund that tracks the S&P 500, without needing to buy tiny slices of all 500 companies yourself.
Illustration: Making Money Simple
The big difference is that you don't own those individual companies outright. Instead, you own the fund, which in turn holds a slice of every company inside that index.
Think of index funds as backing the entire Premier League table rather than betting on one player having a good season. You're not banking on any single company, you're indirectly holding a slice of every single one of them.
That's what makes index funds so powerful: they're a quick and easy way to own thousands of companies, diversify your portfolio, and spread your risk.
Index funds have only existed since 1976, when Jack Bogle, founder of Vanguard, launched the very first one for everyday investors, nicknamed "Bogle's Folly" by sceptics at the time, according to Vanguard's own 50th-anniversary history.
It's fair to say the sceptics were wrong.
But you can take it a step further than investing in just the UK or the US and invest in a global index fund, which tracks the global economy.
That's exactly my approach, and has been since I started investing nine years ago.
Below, I'll explain why this is my approach, why it's more than enough for most "average" investors (nothing wrong with average!), and why it really works.
Index Funds and ETFs: The Basics
An ETF is an Exchange-Traded Fund. At its core, it acts in the same way as an index fund, a basket of stocks bundled together, tracking a particular index.
The main practical differences come down to how they're bought, priced, and accessed. Here's the quick breakdown:
| Index Funds | ETFs |
|---|---|
| Bought and sold like a traditional fund | Bought and sold like an individual share |
| Priced once per day (usually at market close) | Priced continuously while markets are open |
| Mostly limited to broad market trackers (e.g. FTSE 100, S&P 500) | Same broad trackers available, plus niche themes (e.g. AI, clean energy) |
| Available on fewer platforms (though this is changing) | Available on almost every major platform |
| Historically needed a bigger minimum (e.g. £100 lump sum) | Historically more accessible (from as little as £20) |
| Both can now be bought using fractional shares on specific platforms, meaning you can start investing in either one from as little as 1p | |
In practice, most people end up using ETFs rather than traditional index funds, simply because they're more widely available and easier to get started with. That's absolutely fine, because they're doing almost exactly the same job.
Differences aside, both are genuinely one of the best, simplest ways for anyone to invest and grow their wealth.
Popular Indexes to Know
Right, let's make this practical. Here are some of the indexes you'll come across most often:
Single-country and regional
- FTSE 100, the UK's 100 largest companies
- S&P 500, the US's 500 largest companies
- Nikkei 225, Japan's 225 largest listed companies
Most countries have their own index tracking their domestic economy.
You can also invest in thematic indexes, which tend to focus on a particular sector. These often still invest in hundreds, if not thousands, of companies, but tend to be more volatile because they depend on a particular industry doing well.
For people who have a good understanding of an industry (maybe through working in it or having a real passion for it), it can be a good way to accelerate your gains. Some of the most popular thematic indexes are below:
Thematic indexes
- NASDAQ 100, 100 of the largest non-financial companies on the Nasdaq exchange, skewed heavily towards tech
- PHLX Semiconductor Sector Index, tracking the performance of major semiconductor companies
- S&P Global Clean Energy Transition Index, tracking companies driving the shift to renewable energy
But you can also take it a step further and go truly global. These are some of the biggest global index funds out there:
I know, it's a lot of jargon. But strip away the acronyms and these are all largely investing in the same thing: thousands of companies, across dozens of countries, for a tiny fee. Hugely diversified, and about as hands-off as investing gets.
For more information about some of the most popular funds, and where you can invest them, click here and select Fund Availability.
Why I Invest With Index Funds and ETFs
Since I started investing almost a decade ago, I've really only ever used index funds and ETFs.
Passive investing is completely hands-off, and saves me having to constantly change my investments based on what's doing well, what isn't, and what might do well.
That would be active investing, which is when you pick stocks yourself or pay a fund manager to do it, with the aim of trying to beat the return of the market.
Over a 15-year period, around 90% of active fund managers fail to beat their benchmark index, and this pattern holds true across most countries, not just the US, according to S&P Dow Jones Indices' SPIVA Scorecard.
Being "average" isn't usually something to aspire to, but, in investing, the average market return is actually pretty good.
For the last 50 years, the S&P 500 has averaged around 8% in annual returns, once adjusted for inflation. That doesn't mean it'll continue to do that, but it does give a good indication. (source)
Even with slightly below average returns, again based on historical data, you'll likely see more gains than leaving your cash sat in a low-interest savings account getting eaten into by inflation. Remember, though: past performance is never an indicator for future success.
Another reason I love investing this way? Index funds and ETFs are essentially self-cleaning. If a company grows big enough, it simply gets added to the relevant index automatically. If a company's performance declines, they go private, or they go bust, it gets dropped and something replaces it, all without you having to change anything you're doing.
Research by Hendrik Bessembinder found that between 1926 and 2016, just 90 companies, roughly one-third of 1% of every US-listed company in that period, were responsible for over half of the entire US stock market's total wealth creation. Picking the wrong stocks isn't just possible, it's the statistical norm. (source)
It makes it a completely hands-off approach. I don't have to check my portfolio daily, or even monthly. I just set up an automated payment once, and let it do its thing in the background.
Why This Combination Works So Well
- Low fees, so more of your money stays invested and working for you
- No need to time the market, you simply invest on a schedule and let it run
- No need to pick individual stocks, or predict which companies will win
- Instant diversification, spreading your risk across hundreds or thousands of companies at once
This all matters more than people realise... nobody knows who'll be leading the global economy in another 10 or 20 years. A global index fund or ETF means you don't have to guess. Whoever's winning, you'll automatically own a slice of it.
In 1900, the UK was the world's largest stock market at around 24%, with the US a distant second at around 15%. Today, the US dominates at 62%, while the UK has shrunk to just 3.7%. Source: UBS Global Investment Returns Yearbook (Dimson-Marsh-Staunton Database)
You can see my whole approach by watching this video, where I go through literally every account and investment I hold, completely transparently.
It takes about ten minutes a month to set up and manage. I don't try to time the market, and I definitely don't try to pick the next hot ETF. I just keep investing, stay diversified, and let time do the heavy lifting.
Next Steps
Hopefully you're now clear on what an index fund and an ETF actually are, confident in the differences, and ready to start (or keep) building long-term wealth.
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And if you want more hands-on help, whether that's building your entire portfolio strategy, sorting out your pension, or simply having someone to ask questions to, you can see all the ways I can help by clicking the button below.
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