Index funds

Frequently asked questions about index funds

• What is an index fund?
  An index fund (also known as a passive fund) aims to track the performance of a particular index, such as the FTSE 100 or the FTSE All Share. They offer a convenient way to gain exposure to a broad range of shares or bonds at a low cost.
• What's the difference between an active fund and an index fund?

  An active fund will invest in just several companies in the index, perhaps as little as 30-40 in some cases, and the aim is to select the companies with the best potential in order to deliver performance that is much better than the index over the long term. This approach is more complex than simply tracking the index. It involves a great deal of research and costs are higher.

  It can be difficult to unearth active fund managers capable of consistently outperforming an index but we believe the highest-calibre fund managers share a specific set of skills and attributes. We seek those with a long, demonstrable track record of adding value by skill rather than a few lucky decisions. Our favourites can be found on the Wealth Shortlist.

• What is an index?
  An index is a basket of shares that represents the performance of a stock market. So, for example, the FTSE 100 is an index that contains the largest 100 companies listed on the UK stock market. Most major markets have indices that can be used to track their performance, for example the S&P500 in the US. Normally these indices are run by an independent company who sets the rules on what is included and what proportion of the index each company represents. Often the biggest, most widely traded companies are the biggest holdings in the index.
• How do index funds work?

  Most index funds tend to fully replicate an index. For example, a fund tracking the FTSE 100 index will buy shares in all 100 companies. The size of each company within the fund will be proportionate to its size within the index.

  Alternatively, index funds can partially replicate the index. This is where the manager holds a sample of shares which are considered to be representative of the wider index. This often occurs when the index being tracked is difficult or costly to fully replicate.

• Can I take income from an index fund?
  Yes - most index funds come as either income or accumulation units. With income units, income is paid out to fund holders as cash. This could provide you with an income stream or the cash could be reinvested to buy additional units. With accumulation units income is retained within the fund and reinvested, increasing the price of the units. Generally, for investors who wish to reinvest income, accumulation units offer a more convenient and cost-effective way of doing so.