Index funds explained

The main factors you need to consider when investing in an index fund are your goals and how much risk you’re comfortable with, the fees you’re willing to pay and the length of time you’re willing to invest your money for. Deciding on these factors can help you determine if an index fund is for you.

These are the typical risks of investing in an index fund:

• They lack protection: as you can see from the graph above, the stock market has its ups and downs. This means that when you invest in an index fund, you can see great returns when the market is doing well, but equally, it can leave you vulnerable when the market is down.
• Lack of flexibility: index funds don’t allow you to change the index you’re tracking. If you feel that the index your fund is mimicking is going to decrease in value, you can only sell, but not act to change its course, regardless of having that knowledge.
• Little control: index funds don’t have a fund manager, which gives you no control over your portfolio, meaning that if the market goes down, the index fund will go down with it and vice versa. 
• Investing in index funds can be stressful: especially when the market is volatile. Due to the increase or decrease in the value of your shares, you might find yourself constantly checking how the market is performing and making emotional rather than logical decisions.

Which index fund is right for you depends on the type of company you might want to invest in. Index funds track various indexes, which are composed of stocks or assets that can be based on the following:

• Company size: there are index funds that track small, medium or large companies
• Geography: these index funds focus on stocks from companies in different countries or regions of the world
• Industry: you’ll find index funds that focus on consumer goods, technology or any other business sector
• Asset type: some index funds track domestic or foreign bonds, commodities or other asset classes

A good example of an index fund is the American Vanguard 500 Index Fund, which was founded in 1976, and is one of the most successful funds for long-term performance and low cost. The Vanguard 500 faithfully tracks the S&P 500, short for Standard & Poor’s 500 – a stock market index that tracks 500 publicly traded domestic companies, and is considered by many investors to be the best overall measurement of American stock market performance.

In the UK, the iShares Core FTSE 100 UCITS ETF tracks the whole of the FTSE 100 and is recognised as one of the more successful index funds.

If you’re uncomfortable with taking risks but want to maximise your savings pot, you might want to consider investing in a high interest savings account instead. 

Savings accounts such as fixed rate bonds, notice accounts and easy access savings offer competitive interest rates that you’ll receive from the day you open the account until the end of your agreed term. When your fixed term ends, you’ll receive all the money you’ve invested plus the interest you’ve earned.

If you want to quickly and easily open a savings account that can earn a guaranteed return on your investment, register for a Raisin UK Account and apply today. Opening savings accounts with competitive interest rates from a range of UK banks through our marketplace is free, and your money is always protected.