What is an index fund (or tracker)?
An index fund, or tracker, is a fund that simply holds every company in a market index, like the FTSE 100 or the S&P 500, in the same proportions, instead of a manager picking a handful of winners. Because no one is choosing shares, the ongoing charge is very low, and you get instant diversification across hundreds of firms in one holding.
How does a tracker actually work?
An index is just a list of companies measured together, such as the FTSE 100 (the 100 largest firms on the London Stock Exchange). A tracker fund holds all of those companies in roughly the same weights as the index. If a firm makes up 4% of the index, it makes up about 4% of the fund.
When the index changes its members, the fund quietly adjusts to match. There is no forecasting and no stock-picking involved, which is why these are sometimes called 'passive' funds. You are not trying to guess which company will do well; you simply own the whole list.
Why is the ongoing charge so low?
Running a tracker is mostly a rules-based, automated job, so there is no expensive research team to pay for. That keeps the ongoing charge (often shown as the OCF, or ongoing charges figure) very low, sometimes around 0.05% to 0.25% a year. A fund run by a manager choosing shares by hand might charge 0.75% or more.
Over decades, that gap in fees, taken from your pot every single year, can add up to a surprising amount. Seeing the difference in actual pounds, rather than percentages, makes it much clearer.
ETF or index fund: what's the difference?
Both can track the same index; the difference is the wrapper. A traditional index fund is priced once a day, and you deal directly with the fund provider. An ETF (exchange-traded fund) trades on the stock exchange like a share, with a live price that moves through the day.
For a long-term UK saver inside an ISA, the practical difference is often small. ETFs can have slightly lower charges and can be dealt any time the market is open; index funds are simple and can accept regular fixed-pound contributions more easily. Many providers offer both versions of the same underlying tracker.
Acc or Income: what happens to the dividends?
The companies inside a tracker pay dividends, and the fund collects them for you. An 'Income' (Inc) version pays that cash out into your account. An 'Accumulation' (Acc) version keeps the cash inside and reinvests it automatically, so your holding quietly grows without you lifting a finger.
The underlying investments are identical; it is only what happens to the dividends that differs. Acc is popular with long-term savers because the money keeps compounding without a manual step, while Inc suits people who want an actual cash payout to spend or withdraw.
A worked example
Imagine you put £1,000 into a fund tracking the FTSE 100. Instead of owning one or two companies, your £1,000 is spread across all 100, weighted by size. So a giant firm making up 5% of the index holds about £50 of your money, a mid-sized firm at 1% holds about £10, and a smaller member at 0.3% holds about £3. With an ongoing charge of 0.10%, the yearly cost on that £1,000 is roughly £1. One simple holding, and you own a tiny slice of every company in the index.
Common questions
Is a tracker the same as an ETF?
Not exactly. A tracker is any fund that follows an index rather than picking shares. An ETF is one way to hold a tracker, wrapped so it trades on the stock exchange with a live price. A traditional index fund is another wrapper, priced once a day. Both can follow the very same index.
Why are index funds cheaper than managed funds?
Because no one is paid to research and pick shares. A tracker just copies a published list of companies, which is largely automated. That removes the cost of a fund-management team, so the yearly charge can be a fraction of what an actively managed fund charges. Lower ongoing fees leave more of your money invested.
Does one tracker really give me diversification?
A single global tracker can hold thousands of companies across many countries and industries in one fund. That spread means no single company can sink your whole holding. It is not risk-free, because the whole market can fall together, but it removes the danger of resting everything on just one or two firms.
Where to next
General information to help you understand investing, not advice about your situation. Figures are illustrative and the rules can change - always check gov.uk or your provider for the latest.