Index Funds vs ETFs: What’s Best for UK Investors?
Both index funds and ETFs let you invest broadly at low cost. They often track the same markets and can look interchangeable, but they behave differently when you buy and how you pay fees. This guide explains the differences for UK investors and gives a simple way to choose.
What Is an Index Fund?
An index fund is a mutual fund that aims to match a market index such as the FTSE 100 or a global tracker. You place orders during the day and the trade is executed once at the end of the day at the fund price known as NAV. Popular providers include Vanguard, Fidelity, and HSBC.
What Is an ETF?
An ETF is a fund that also tracks an index, but it trades on the stock exchange like a share. You can buy and sell throughout the trading day and the price moves in real time. You will see a buy price and a sell price known as the bid and ask.
Key Differences for UK Investors
| Feature | Index fund | ETF |
|---|---|---|
| Trading | Once per day at NAV | Any time during market hours |
| Dealing costs | Usually no dealing fee for regular investments on some platforms | Broker dealing fee may apply per trade |
| Bid-ask spread | Not applicable | Applies. Wider spreads increase cost |
| Ongoing fees | OCF typically slightly higher | OCF often slightly lower |
| FX on non-GBP markets | Platform may convert in the fund | Broker FX fee may apply when buying non-GBP ETFs |
| Minimums and automation | Great for monthly direct debits and automatic investing | Great for lump sums and ad hoc buys |
| Fractional investing | Invest by pound amount automatically | Depends on broker. Some support fractional ETF units |
| Where to buy | Investment platforms such as Vanguard, AJ Bell | Share dealing apps and brokers such as Freetrade, Trading 212, AJ Bell |
Performance: Which Is Better?
If both track the same index, performance is usually very close. Differences come from costs and tracking error. Over long periods, small fee gaps matter. A 0.10 percent difference every year compounds into a noticeable gap over decades.
Dividends: Accumulation vs Distributing
Both index funds and ETFs come in two types:
- Accumulation units automatically reinvest dividends back into the fund
- Distributing units pay cash dividends to your account
Pick the version that fits your goal. Accumulation is simple for long term growth. Distributing helps if you want income.
Important UK Considerations
- Tax wrappers. You can hold both in a Stocks and Shares ISA or a SIPP. Inside these wrappers, gains and dividends are tax free.
- PRIIPs rules. UK investors generally buy UK or EU domiciled ETFs that provide a Key Information Document. US domiciled ETFs are usually not available on UK platforms.
- Stamp duty. UK listed ETFs are normally exempt from UK stamp duty on purchases. Individual UK shares are not.
- Platform fees. Some platforms charge a percentage fee on funds and a flat fee on shares and ETFs. This can tilt the maths in favour of one or the other depending on your account size.
- FX fees. If you buy non-GBP ETFs, your broker may charge FX conversion on each trade. Index funds may handle currency inside the fund without a retail FX fee.
How to Choose: Quick Framework
| Your situation | Leans to index fund | Leans to ETF |
|---|---|---|
| You want a monthly direct debit set and forget | Yes | No |
| Your broker charges dealing fees on ETFs | Yes | No |
| You want to buy during the day at a live price | No | Yes |
| You care about the smallest possible OCF | Maybe | Often yes |
| You invest lump sums and rarely trade | Either | Yes |
Example Costs
Assume £300 per month into a global tracker for 12 months on a platform that is free for fund regular investing but charges £5 per ETF trade:
- Index fund twelve purchases, zero dealing fees, OCF applies
- ETF twelve trades at £5 each equals £60 in dealing fees plus any FX and the OCF
On a platform with free ETF trades but a percentage platform fee on funds, the result may flip. Always compare your platform’s charges.
FAQs
Are ETFs riskier than index funds?
They track the same markets, so market risk is similar. The main practical differences are dealing fees, the bid-ask spread, and intraday pricing.
Can I drip feed into ETFs each month?
Yes. Some brokers offer recurring ETF buys and fractional units. Check dealing and FX fees so frequent small trades are still cost effective.
Which is better in an ISA or SIPP?
Both work well. Focus on total cost on your platform and whether you value automation or live pricing.
What is tracking error?
The small difference between a fund’s return and the return of the index it follows. Lower is better.
Do I pay UK stamp duty on ETFs?
Most UK listed ETFs are exempt from UK stamp duty on purchases. Check your broker’s fee schedule for any other charges.
Final Thoughts
Index funds and ETFs both do the job for long term investing. If you want simplicity and automatic monthly investing, index funds are hard to beat. If you want live pricing, tight OCFs, and flexible trading, ETFs fit well. Whichever you choose, keep costs low, diversify widely, and stay invested.