What Is An Index Fund?

If you are wondering what is an index fund, the simplest answer is this: it is a fund that tries to copy the performance of a market index.

That sounds more technical than it needs to. An index fund is basically a basket of investments built to follow a list, such as the FTSE 100, S&P 500 or MSCI World. Instead of you picking individual companies one by one, the fund holds a collection of them according to the rules of the index.

This is one of the main reasons index funds are popular with beginner investors. They can be simple, diversified and relatively hands-off compared with trying to choose individual shares. That does not make them risk-free. Investing means your capital is at risk, markets can fall as well as rise and past performance is not a guide to future returns.

Nothing here is financial advice or a recommendation. I am explaining the term in plain English. You can read my full approach to that on the disclaimer page.

Quick answer: what is an index fund?

An index fund is an investment fund that aims to track a specific index.

For example:

• A FTSE 100 index fund aims to follow the FTSE 100
• An S&P 500 index fund aims to follow the S&P 500
• A global index fund may aim to follow a worldwide share index

The key idea is that the fund is not usually trying to beat the market. It is trying to follow a chosen slice of the market.

What is an index?

An index is a list used to measure part of a market.

You can think of it like a scoreboard. It tracks a group of companies or investments and shows how that group is performing overall.

Common examples include:

• FTSE 100: large companies listed in the UK
• S&P 500: large companies listed in the US
• MSCI World: companies from developed markets around the world

The index itself is not something you normally buy directly. It is the list or measurement. An index fund is one way to invest in something designed to follow that list.

How does an index fund work?

An index fund usually works by holding the investments inside an index, or by using a method designed to closely match the index.

In plain English, if an index includes hundreds of companies, the fund tries to give you exposure to those companies in a similar way.

So if a company becomes a bigger part of the index, it may become a bigger part of the fund. If a company leaves the index, the fund may remove it too.

That is why index investing is often described as passive investing. The fund is following a set of rules rather than relying on a fund manager to decide which companies are going to do best.

Index fund vs individual shares

Buying an individual share means buying a small ownership stake in one company.

An index fund is different because it usually spreads your money across many companies at once.

Individual shares

With individual shares, your result depends heavily on what happens to the companies you choose.

If you buy one company and it does well, you may benefit. If it performs badly, your investment can fall sharply. You are taking company-specific risk.

Index funds

With an index fund, you are not usually betting on one company. You are buying a broad basket.

That does not remove risk. If the whole market falls, the index fund can fall too. But it does reduce the risk of one single company having too much influence, especially when the fund is broad and diversified.

This is one of the reasons I became more interested in funds after my earlier experiments with more exciting, concentrated areas of the market. My first serious investment was in a technology-focused ETF, and although it did well for me at the time, that is not something I see as a guarantee or a repeatable shortcut. Past performance is not a promise.

The lesson I took from it was not “pick the hottest sector”. It was that keeping things simple and diversified can be a much calmer way to learn.

Index fund vs ETF

This is where beginner investing language gets confusing.

An ETF, or exchange-traded fund, is a type of fund that trades on a stock exchange. You can usually buy and sell it through an investing platform during market hours, in a similar way to a share.

Many ETFs are index funds because they track an index.

For example, an ETF might track:

• The S&P 500
• The FTSE 100
• A global shares index
• A bond index

But the terms are not identical.

Are all ETFs index funds?

No.

Many ETFs track indexes, but not every ETF is a simple broad-market index fund. Some ETFs focus on sectors, themes, commodities, bonds or more specialised strategies.

So the overlap looks like this:

• Some index funds are ETFs
• Some index funds are not ETFs
• Some ETFs are index funds
• Some ETFs are not index funds

That is why I try not to use the words as if they mean exactly the same thing.

If you want to go deeper on ETFs specifically, I have a separate section for that here: ETF articles.

You can also use the broader investing terms glossary if you want the surrounding jargon explained in one place.

Why do beginners hear so much about index funds?

Index funds come up a lot because they solve several beginner problems at once.

They can offer:

• Diversification: exposure to lots of companies instead of one
• Simplicity: one fund can cover a large part of a market
• Transparency: you can usually see which index the fund tracks
• Lower decision fatigue: fewer choices than picking individual shares

For me, this matters because the biggest improvement in my own investing was not finding the perfect investment. It was building a simple process I could repeat. Automation, broad funds and fewer decisions made investing feel less like a daily test.

That does not mean index funds are automatically right for everyone. Different people have different goals, timeframes and risk tolerance. The important thing is understanding what the thing is before putting money into it.

For more beginner foundations, start here: Start here or browse the foundations section.

What can an index fund invest in?

An index fund can track different types of markets.

Common examples include:

Share index funds

These track shares in companies. Examples might include funds following the UK market, US market or global markets.

Bond index funds

These track baskets of bonds. Bonds are different from shares and have their own risks.

Sector index funds

These track a specific industry or theme, such as technology, healthcare or energy. These can be more concentrated than broad market funds.

Global index funds

These aim to give exposure to companies across multiple countries. They can still fall in value, but they are usually broader than a single-country or single-sector fund.

Is an index fund safe?

No investment fund is completely safe.

Index funds can reduce some risks, such as relying on one company, but they do not remove market risk. If the market or index falls, the fund can fall too.

The level of risk depends on what the fund tracks. A broad global index fund is very different from a narrow sector index fund, even if both are technically index funds.

That is why the name alone is not enough. I always want to understand:

• What index does it track?
• What does it actually hold?
• Is it broad or concentrated?
• Is it shares, bonds or something else?
• What are the costs?
• Does it fit the level of risk I am willing to take?

Again, that is not a checklist telling anyone what to buy. It is just the kind of thinking I wish I had slowed down and done earlier.

The plain English version

Here is the simplest way I think about it:

An index is the list.

An index fund is a fund built to follow the list.

An ETF is a fund that trades on the stock exchange, and many ETFs follow indexes.

An individual share is one company.

That is the whole idea. Index funds are not magic and they do not guarantee returns, but they can be a simple way to understand diversified investing without trying to pick every company yourself.