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.
Index Funds and ETFs: At A Glance
| Pros | Cons |
|---|---|
| Extremely low fees compared to actively managed funds | Fees still exist, and small percentages add up over decades |
| Instant diversification across hundreds or thousands of companies | You also own the underperforming companies, not just the winners |
| Historically strong long-term returns, around 7% a year after inflation | Past performance is never a guarantee of future returns |
| Completely hands-off once it's set up | Results build slowly over years, not overnight |
| You'll get the market's average return, which beats most professionals | You'll also never beat the market, only ever match it |
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 is an index fund?
- What's the best index fund?
- What are the differences between index funds?
- Are index funds and ETFs the same thing? If not, what's the difference?
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' top 500).
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.
Plus, imagine having to buy all those companies yourself, only for the list to change. Bloody nightmare!
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!
(To be precise: the very first index fund was actually created in 1971 by Wells Fargo, for luggage brand Samsonite's pension fund. Bogle's achievement was making index investing available to everyday retail investors like us.)
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.
So What's an ETF Then?
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, but there's also 'active' ETFs and more niche thematic ETFs (e.g. AI, clean energy, etc.) |
| Available on fewer platforms (though this is changing) | Available on almost every major platform |
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
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' 500 largest companies
- Nikkei 225, Japan's 225 largest listed companies
- NASDAQ 100, 100 of the largest non-financial companies on the Nasdaq exchange
It's not just the UK, US, and Japan that have index funds. In fact, most countries have their own index tracking their domestic economy.
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 in them, click here and select Fund Availability.
So What's The Downside?
I don't want this to feel like a sales pitch, so let's be honest about the downsides too.
You will never beat the market. By design, an index fund or ETF simply matches the return of whatever index it tracks, no more, no less. If a handful of companies inside that index have an incredible year, you'll only capture your small slice of that gain, not the whole thing.
To be fair though, roughly 90% of professional fund managers fail to beat the market too. So while you're giving up the small chance of massively outperforming, you're also giving up the much bigger chance of badly underperforming.
The Honest Downsides
- You'll never beat the market, only ever match it
- No overnight riches, this is a long-term game
- It can feel boring compared to picking your own stocks
- They can still be volatile and experience sharp downturns during market corrections or crashes
You also won't get rich quick. Index funds and ETFs are built for patient, long-term growth, not overnight wins. If you're hoping to turn £500 into £50,000 within a year, this isn't that, and honestly, very few legitimate strategies can promise that either.
People often chase individual stocks because they can grow your money much faster than a simple index fund or ETF.
The 20 best-performing S&P 500 stocks between 2005 and 2024 averaged a 25.8% annual return, more than double the index's own 10.4% average over the same period, according to Morgan Stanley's Counterpoint Global Insights, via Visual Capitalist.
The catch is, of course, knowing which 20 of the 500 to pick. Remember that, because companies fail, merge, or go private, you'd actually be trying to pick from a pool far larger than 500. Then, add in the fact that the best 20 could change at any moment. Talk about trying to find the needle in the haystack!
There's also an element of boredom, if I'm honest. You won't get the thrill of picking the next Tesla or Nvidia before everyone else, but you also won't get the stress that what you picked will crash the day after you buy it!
Investing with index funds or ETFs offers greater diversification, but that doesn't mean you're immune from falling markets.
Markets can and do fall, sometimes significantly. You may not experience such drastic dips in your portfolio if you're only invested in index funds and/or ETFs, but you still need to be prepared for when it happens. And it will happen.
Investing is for the long term, and the value of your investments may drop, especially in the short term. It's always worth bearing that in mind before investing, regardless of whether you choose index funds, ETFs, or something else.
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.
Why's that? Because you'll still beat the large majority of active investors trying to beat the market, meaning your actual returns will be above average.
For the last 50 years, the S&P 500 has averaged around 7% in annual returns, once adjusted for inflation, according to historical return data from NYU Stern School of Business. That doesn't mean it'll continue to do that, but it does give a good indication.
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, titled Do Stocks Outperform Treasury Bills?, found that, between 1926 and 2016, just 4% of listed companies are responsible for the net gain of the entire US stock market since 1926.
The updated study in 2025 (One Hundred Years in the U.S. Stock Markets) found that, between 1926 and 2025, just 46 firms account for half of the $91 trillion in net wealth creation over the full century.
Re-read both of those stats. Insane!
Another study by Bessembinder, now looking at the global market and covering 64,000 stocks across 43 countries, found the pattern holds globally, too:
The top-performing 2.4% of firms account for all of the net global stock market wealth creation from 1990 to December 2020.
Once again. Insane!
And to me, all of this data shows just how hard it is to pick winning stocks. So, I'd rather own as many as possible inside one index fund.
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, and there's no better example than looking at how global market leadership has shifted over the last 125 years.
Global Market Dominance: Then vs Now
Source: UBS Global Investment Returns Yearbook (Dimson-Marsh-Staunton Database)
In 1900, almost nobody would have predicted the US would come to dominate global markets the way it does today. In another 10, 20, or 50 years, leadership could shift again, and nobody knows who'll be leading then either.
A global index fund or ETF means you don't have to guess: it's constantly self-rebalancing, so you'll automatically own a slice of whoever's winning.
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 to set up and then even less per month to 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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