Index Funds UK – Ultimate Guide

When it comes to index funds, UK investors have a wealth of products to choose from. The problem is there are almost too many, giving many would be investors a severe dose of analysis paralysis.

In this article we give you the key information you need to choose the right index fund and get investing.

We’ve tried to answer the most frequently asked questions in order so without further ado lets get to it.

What is a market index?

A market index is a collection of shares grouped to represent a section of the stock market.

The most famous example being the S&P500, which tracks the biggest 500 publicly traded companies in the US. The equivalent in the UK is the FTSE100.

What is an index fund?

An index fund is a basket of shares that track an index. They are often referred to as tracker funds or index trackers.

When you buy a share of an S&P500 index fund your money is automatically divided between the 500 S&P500 companies in the correct proportions.

Similarly, if you buy a share of a FTSE100 index fund your money will be split between the 100 FTSE100 companies.

What is an ETF?

There are all kinds of investing funds UK investors can choose to buy. Exchange Traded Funds (ETFs) are a type of fund that trades on a stock exchange just like an individual share.

In the UK ETFs aren’t quite as popular as they are in the US and Europe but they are gaining popularity all the time. And rightly so, because they have lots of advantages. What’s most important is the fact that ETFs can also provide indexed investments.

According to Barclays, the most popular ETF UK investors choose is the Vanguard S&P 500 UCITS ETF (VUSA).

The advantages of index funds and index tracking ETFs

The differences between index funds and index tracking ETFs is very small. If you are interested you can read more about this here but in short both are extremely tax efficient, low cost, easy to invest in and provide the opportunity to beat 90% of your fellow investors.

How to invest using index funds

Investing using index funds couldn’t be simpler. Just follow the steps below:

Choose an index to follow
Choose an investment platform
Choose an index fund that follows your desired index
Add fresh money whenever you have some free

It’s worth going over these in a bit more detail.

Choose an Index

There are a wealth of investor indices to choose from.

As already mentioned, the most recognised UK stock market index is the FTSE100.

Commonly termed ‘the Footsie,“ this index tracks the 100 largest public companies by market capitalisation that trade on the London Stock Exchange (LSE).

And in fact the name comes from combining LSE with the Footsie’s original parent company, the Financial Times.

FT = Financial Times / SE = Stock Exchange.

Some UK investors only invest in funds that follow this one index.

The most popular UK investor indices are shown below:

FTSE100 (100 largest UK companies listed on the London Stock Exchange which are classed as large companies)
FTSE250 (The next biggest 250 which are classed as medium sized companies)
FTSE350 (A combination of the above)
FTSESmallCap Index (The next 269 companies (351 to 619) which are classed as small companies)
FTSEAll-Share Index (All of the above combined)

Index Fund Diversification

Unless you are a sophisticated investor, the more companies the merrier. That’s because the more companies you track the more chance you have of holding the winners and it’s these that will govern your returns.

Yes, more companies could equate to more rubbish, but the winners will more than make up for the losers. It’s simple mathematics really.

Whereas a company can only loose 100% of it’s value, its potential for growth is infinite. 200%, 500%, 2000% take your pick. The Amazon’s of this world more than make up for those companies that go bankrupt.

If you’d divided £10K equally between 10 companies 25 years ago and one of them was Amazon. Even if all the others went bankrupt, you’d still be a multimillionaire today.

So with that in mind you might think the FTSEAll-Share Index is the one to go for UK investors because it contains the most companies.

And once upon a time when it was expensive to invest abroad you’d be right, but through index funds UK investors have the whole world at their door.

As already mentioned you can choose to invest in the US via a fund that tracks the S&P500 or one of many other US indices or if you’d prefer you can invest in a French index, a German one or a Chinese one.

In fact, not only can you invest in other countries’ indices, you can also invest in the entire world in one fund.

Some of the biggest global indices are:

FTSE All World
MSCI ACWI
FTSE Global All Cap
MSCI World

When you invest a fund that follows a global index your money will be shared between thousands of companies.

There are also indices that focus on certain characteristics like income or socially responsible investing. Here are a few more alternatives:

FTSE UK Equity Income
FTSE All-World High Dividend Yield
FTSE ESG Index Series
MSCI World SRI
MSCI World High Dividend Yield

People do like tweaking their portfolios but unless you really know what you are doing it may not be the best way forward. Choosing UK over global or large companies over small companies is essentially an active bet that whichever one you choose will outperform the wider market.

Successful active bets are notoriously hard to pull off. Just take a trip over to S&P global and check out their SPIVA research if you don’t believe me, where they show that 90% of professionals underperform their indices.

Unless you are confident you can beat the wider market (90% of pros can’t), you are probably better sticking with the most diversified index you can get your hands on cheaply. FTSE All World & MSCI ACWI would be good examples.

Bond index funds

In addition, most investors will be well served investing in a bond index fund to go along with their stocks.

Everybody has different ideas about how much of your money should be invested in bonds compared to stocks. You can read more about it here if you are interested. However, these days I like the 4% rule, where you invest 4% of your money in stocks for every year you plan to invest.

Investing for 10 years, then put 40% of your money in stocks and the rest in bonds. A 20 year investment time horizon equates to 80% of your money in stocks and the remainder in bonds.

Bonds are a little complicated so its worth doing a bit of background reading. You can start here, but here’s a quick intro:

Bonds don’t go up as much as stocks, but they don’t go down as much as stocks either. The more bonds you have in your portfolio the lower your chances of panic selling during stock market crashes. That’s important because those who panic sell either end up getting back into the market at much higher prices or more likely never get back in again.

Either of which would crystallise losses, that a bit of patience would have eradicated anyway.

So worth having then but you should be aware that bonds come with three key risks. These are duration, credit and currency and it’s worth going over these three in a bit more detail.

The risks of investing in bonds

Duration / Interest Rate Risk – Bonds pay interest like savings accounts but usually better. The longer the duration of a bond the more interest rate it is likely to pay. However, as duration increases so does a bonds susceptibility to interest rate risks. Just know that when interest rates go up, bond prices go down and that you can minimise this risk by investing in bond index funds with lower durations.
Credit Risk – When you invest in a bond you essentially lend some organisation money and they pay you interest for your trouble. As with anytime you lend out your hard earned cash, there is always a risk you don’t get your money back. Bonds are no different. All things being equal, the ones with the highest interest rates usually come with the most risk that you don’t get your money back. You can minimise this risk by investing in developed market government bond index funds. Think the US, UK, Germany and Japan.
Currency Risk – Bonds come in a particular currency and as such there is always a risk of that currency devaluing against others. What you want to avoid is the currency of your bond devaluing against the currency you use. The way to avoid this is by investing in bonds denominated in the currency you use. A UK investor should usually stick to UK bonds denominated in pounds. (Expats who don’t know where they are going to retire might want to read this).

So based on the above, a safe bond index for a UK investor would be a short term UK government bond index.

There’s a list of some of the larger bond indices below. The FTSE UK Conventional Gilts – Up to 5 Years Index is going to be the kind of thing a lot of UK investors would do well to consider. You are essentially lending pounds to the UK government for a short time period.

That said, due to higher interest rates and the fact that they have the potential to actually increase in value when stocks decrease, some investors prefer to accept duration risk and invest in longer term bonds. Typically, they do this by investing in a fund that contains bonds of all durations.

Similarly, some investors like to invest in international bonds that are hedged back into their national currency.

Though, my preference would be for short term UK government bonds all of these approaches are sensible and I don’t think you would go too far wrong with any of them.

Bond indices

(Bank of America) Merrill Lynch Global Bond Index
Bloomberg Barclays Global Aggregate Bond Index
Citi World Broad Investment-Grade Bond Index (WorldBIG)
Bloomberg Barclays US Treasury Index
Barclays Inflation-Linked Euro Government Bond Index
Citi World Government Bond Index (WGBI)
FTSE UK Gilts Index Series
J.P. Morgan Government Bond Index
FTSE UK Conventional Gilts – Up To 5 Years Index

Choose an Investment platform

Before choosing index funds UK investors should usually choose an investment platform.

Whilst not all platforms provide access to all funds, they are almost guaranteed to provide access to a fund which tracks the index you want to follow.

When choosing an investment platform, good support and ease of use are key qualities to look for. However, the factor likely to impact your investment returns the most is fees. There are all kinds of costs associated with investing platforms but the main ones you need to consider are account fees and commissions.

Commissions are the costs incurred when you buy or sell a share of your index fund. They can be anything from £0 to about £25. That’s a big difference!

Account fees are charges simply for having an investment account. They can come as a fixed fee anywhere between £0 to £150 or as a percentage typically between 0.0-0.45%. Again, a big difference!

I’m sure it goes without saying that the nearer you get to zero for all these fees the better. We’ve looked at a range of investment platforms here if you are interested.

Choose an Index fund

Once you’ve chosen your index to follow all you need to do is find a fund that follows it.

If your investment platform provides access to multiple funds that invest in the index you want to follow, it usually makes sense to choose the one with the lowest Ongoing Charges Figure (OCF).

I’m a Vanguard tracker fan, but if I were to invest in a FTSE 100 tracker I’d probably go with the iShares version because it charges 0.07% vs 0.09% for Vanguard. Every penny counts!

Now, some people will argue that you need other things in your investment portfolio like commodities, income or property so I’d be remiss if I didn’t make a few comments on that.

Keep it simple

First of all, the evidence is pretty compelling that the simpler you keep things with investing, the more successful you are likely to be.

Most widely diversified index funds will contain plenty of exposure to commodities and property. If you add them in individual funds you add complexity and costs, which most of the time are going to be unwarranted.

As for income focused funds which provide you with a larger dividend, these have two major problems as far as I can see.

The first being they tend to contain older more established companies that are no longer growing. Think oil, utilities and banking for example. Whilst this type of company does tend to pay out a higher dividend, they don’t have as much growth potential as other companies and so their share price doesn’t tend to increase as much as some of the others do.

In addition, dividends are subject to tax. Even if you keep your investments in a tax sheltered account to avoid income tax, you still may be liable for withholding tax which is typically somewhere between 15 and 30%.

Index funds available in the UK

Here’s a list of index funds you could buy. The number in brackets is the fund ID or ticker. You can use this to find a fund on your investment platform.

The OCF is your ongoing charges figure. It is charged annually as a percentage of the balance you have invested in that fund. £10k invested in a fund with an OCF of 0.05% means it is costing you £5 annually to invest in that fund.

Except for those listed under Small UK Companies, all funds listed below can be considered pretty low cost. All things being equal though, lower tends to equal better.

Large UK companies (including FTSE100 trackers & funds that contain all sizes)

HSBC FTSE All Share Index Fund Institutional (GB0030334345) OCF 0.02%
Lyxor Core Morningstar UK ETF (LU1781541096) OCF 0.04%
L&G UK Equity ETF (IE00BFXR5R48) OCF 0.05%
iShares UK Equity Index Fund D (GB00B7C44X99) OCF 0.05%
Fidelity Index UK Fund P (GB00BJS8SF95) OCF 0.06%
HSBC FTSE All Share Index Fund C (GB00B80QFX11) OCF 0.06%
Vanguard FTSE UK All Share Index Unit Trust (GB00B3X7QG63) OCF 0.06%
iShares Core FTSE 100 UCITS ETF (ISF) 0.07%
Vanguard FTSE 100 UCITS ETF (VUKE) 0.09%

Medium Sized UK companies (including FTSE250 trackers)

Amundi Prime UK Mid and Small Cap ETF (PRUK) OCF 0.05%
Vanguard FTSE 250 ETF (VMIG) OCF 0.1%
HSBC FTSE 250 Index Fund C (GB00B80QG052) OCF 0.12%
iShares FTSE 250 UCITS ETF (MIDD) 0.40%

Small UK companies

Schroder Institutional UK Smaller Companies Fund (GB0007893984) OCF 0.52%
JP Morgan UK Smaller Companies Fund (GB0031835001) OCF 0.6%
Baillie Gifford British Smaller Companies B Fund (GB0005931356) OCF 0.67%

Global trackers

HSBC FTSE All-World Index Fund C (GB00BMJJJF91) OCF 0.13%
iShares MSCI ACWI ETF (SSAC) OCF 0.20%
Fidelity Allocator World Fund W (GB00B9777B62) OCF 0.20%
Vanguard FTSE All-World ETF (VWRL) OCF 0.22%
Vanguard LifeStrategy 100% Equity Fund (GB00B41XG308) OCF 0.22%
Vanguard FTSE Global All Cap Index Fund (GB00BD3RZ582) OCF 0.23%

Developed world trackers

Amundi Prime Global ETF (PRWU) OCF 0.05%
L&G Global Equity ETF (LGGG) OCF 0.1%
Lyxor Core MSCI World ETF (LCWL) OCF 0.12%
Vanguard FTSE Developed World ETF (VHVG) OCF 0.12%
SPDR MSCI World ETF (SWLD) OCF 0.12%
iShares Developed World Index Fund D (IE00BD0NCL49) OCF 0.12%
Fidelity Index World Fund P (GB00BJS8SJ34) OCF 0.12%

Intermediate duration UK bonds

Lyxor Core FTSE Actuaries UK Gilts ETF (GILS) OCF 0.05%
Invesco UK Gilts ETF (GLTA) OCF 0.06%
Vanguard UK Gilt ETF (VGVA) OCF 0.07%
iShares Core UK Gilts ETF (IGLT) OCF 0.07%
Fidelity Index UK Gilt Fund P (GB00BMQ57G79) OCF 0.1%
iShares GiltTrak Index Fund (IE00BD0NC250) OCF 0.1%

Short duration UK bonds

Lyxor FTSE Actuaries UK Gilts 0-5Y ETF (GIL5) OCF 0.05%
Invesco UK Gilt 1-5 Year ETF (GLT5) OCF 0.06%
L&G UK Gilt 0-5 Year ETF (UKG5) OCF 0.06%
iShares UK Gilts 0-5 ETF (IGLS) OCF 0.07%

Global bonds

iShares Core Global Aggregate Bond ETF (AGBP) OCF 0.1%
SPDR Bloomberg Global Aggregate Bond ETF (GLAB) OCF 0.1%
Vanguard Global Aggregate Bond ETF (VAGS) OCF 0.1%
Vanguard Global Short Term Bond Index Fund (IE00BH65QG55) OCF 0.15%
Vanguard Global Bond Index Fund (IE00B50W2R13) OCF 0.15%

What are the best UK index funds?

Surprisingly, the most popular exchange traded index funds for UK investors are those focused on the US. However, my guess is, this is institutions choosing what to invest in, rather than individuals.

Many UK investors I talk to who manage their own money prefer UK indices like the FTSE All Share and the FTSE100 and that makes sense because these indices contain more companies they recognise.

Even those investors that don’t focus on the UK, do tend to overweight the amount of money they allocate to UK companies without really understanding what this could mean.

Historically, investing in UK companies made some sense because these funds were cheaper than their international equivalents, but nowadays that’s not the case. Investing in UK funds has a problem called home bias. You can read more about it here, but the headline being, its better to go global.

Additionally, as we’ve already mentioned most investors would do well to have stocks and bonds in their investment portfolio.

As a result, it makes sense to invest in a fund that contains both so for most UK residents the best index funds to invest in would be one of Vanguard’s LifeStrategy series funds.

These are low-cost, one-stop-shop portfolios that provide broad exposure across geographies and asset classes. You get stocks and bonds in one index fund. There are five basic funds in the range as follows:

Vanguard Life Strategy 20% equity fund
Vanguard Life Strategy 40% equity fund
Vanguard Life Strategy 60% equity fund
Vanguard Life Strategy 80% equity fund
Vanguard Life Strategy 100% equity fund

The percentage figure indicates the percentage of your money invested in stocks. So using the 4% rule discussed above. If you were investing for 10 years you’d choose a Vanguard Life Strategy 40% equity fund.

They all have OCFs of 0.22% although depending on which one you choose, on paper its possible for transaction costs to add 0.01% which means you’d pay 0.23%.

You can tilt them towards or away from the UK and they come in accumulating and distributing varieties. Accumulating being where dividends are automatically reinvested in the funds rather than being distributed to your investment account as cash.

You can see the funds here. (And rest assured we have no connection to Vanguard by the way, they just provide great low cost index funds).

Of course not all investors will have access to these.

Combining any one of the global trackers above with a global bond fund would give you something similar.

Index funds UK – The bottom line

UK investors have a wealth of products to choose from.

Most investors will be best investing in a combination of stock and bond index funds.

A Vanguard Life Strategy index fund is definitely one of the best index funds to invest in. However, anybody can put something similar together by combining a global index fund with a global bond fund.