ETF vs. Index Fund: Which is the Right Low-Cost Investment for You?
Our UK guide explains the difference between ETFs and index funds. Compare fees, trading, pros, cons, and find out which is right for your ISA or pension.
When you decide to start investing, you’ll quickly encounter two of the most popular and powerful tools for building wealth: ETFs and index funds. Both offer a simple, low-cost way to own a diversified slice of the stock market, but they have key differences in how they are bought, sold, and structured. Understanding these differences is crucial to choosing the right one for your investment style.
At Plouta, our mission is to demystify finance and empower you to make confident investment decisions. This guide will provide a detailed comparison of ETFs and index funds in the UK, explaining exactly what they are, their pros and cons, how their costs differ, and which might be the better choice for your financial goals.
What You Will Learn in This Guide ⤵
The Core Concept: What ETFs and index funds are and why they're so popular.
The Key Differences: A breakdown of how they trade, their costs, and structure.
A Side-by-Side Comparison Chart: An easy-to-read summary of the main points.
Pros and Cons: A balanced look at the advantages and drawbacks of each.
Which is Best for You?: Matching the right investment to your personal strategy.
The Foundation: What Are Passive Index Investments?
Before we compare, it's important to understand what ETFs and index funds have in common. Most are passive investments designed to track a specific market index.
What is an index? An index is simply a list of companies representing a particular part of the market. For example, the FTSE 100 is an index of the 100 largest companies listed on the London Stock Exchange. The S&P 500 is an index of 500 of the largest companies in the US.
Passive Investing: Instead of trying to pick individual winning stocks to "beat the market" (which is very difficult and expensive), a passive fund simply aims to match the performance of its chosen index. If the FTSE 100 goes up by 8%, the fund aims to go up by 8% (minus a small fee).
This passive approach is the reason why both ETFs and index funds are very low-cost and are considered an excellent way for most people to invest for the long term.
What is an Index Fund?
An index fund (often called a tracker fund) is a type of mutual fund. It's a collective investment that pools money from many investors to buy all (or a representative sample of) the companies in a specific index.
How it's traded: You buy and sell units directly from the fund management company (like Vanguard or Fidelity). Crucially, index funds are only priced once per day, after the market closes. This price is called the Net Asset Value (NAV). Any buy or sell orders you place during the day will all be executed at that single end-of-day price.
What is an ETF (Exchange Traded Fund)?
An ETF also tracks an index, but it is structured and traded differently. As the name suggests, it is an "exchange-traded" fund.
How it's traded: You buy and sell shares of an ETF on a stock exchange throughout the day, just like you would with an individual company share (e.g., a share of Apple or BP). Its price fluctuates constantly during market hours based on supply and demand.
The Key Differences: ETF vs. Index Fund
While both often track the same indices, their mechanics create four key differences for you as an investor:
Trading and Pricing:
ETFs: Trade like stocks. You can buy and sell them at any time during the trading day (intraday trading). Their price is live and changes by the second.
Index Funds: Trade only once per day at the closing price (NAV).
Cost Structure:
ETFs: Often have very low annual fund charges (Ongoing Charges Figure - OCF). However, because they trade like shares, you may have to pay a dealing fee to your investment platform each time you buy or sell. There is also a small "bid-ask spread" – a tiny difference between the buying and selling price.
Index Funds: The OCF might be slightly higher than an equivalent ETF, but most UK investment platforms allow you to buy and sell index funds with no dealing fees.
Minimum Investment:
ETFs: The minimum investment is simply the price of one share. This can be very low, allowing you to get started with a small amount.
Index Funds: Some fund providers require a higher minimum initial investment (e.g., £100, £500, or more) or a commitment to a regular monthly investment (e.g., £25/month).
Tax Efficiency (Outside of an ISA/Pension):
In the UK, this is less of a factor than in the US, as both are very tax-efficient. However, due to their internal structure, ETFs can sometimes be slightly more tax-efficient in a taxable General Investment Account (GIA). Their creation/redemption process can result in fewer taxable capital gains distributions to investors compared to traditional mutual funds. Inside an ISA or SIPP, this difference is irrelevant as all growth is tax-free anyway.
| Feature | ETF (Exchange Traded Fund) | Index Fund (Mutual Fund) |
|---|---|---|
| How it's Traded | Like a share, throughout the day on a stock exchange. | Directly with the fund manager, once per day at the closing price. |
| Pricing | Live, intraday price fluctuations. | Priced once at the end of the trading day (Net Asset Value - NAV). |
| Dealing Costs | Yes. Often incurs a dealing fee from your platform (e.g., £5-£12) and a bid-ask spread. | No. Usually free to buy and sell on most major UK platforms. |
| Fund Charges (OCF) | Generally very low, sometimes slightly lower than the equivalent index fund. | Also very low, but might be marginally higher than the ETF version. |
| Minimum Investment | The price of one share (can be very low). | Often requires a lump sum (£100+) or a regular monthly investment (£25+). |
| Suitability | Good for lump-sum investments or for those who want trading flexibility. | Excellent for regular monthly investing ("drip-feeding") due to no dealing fees. |
| Best For... | Investors who value intraday trading and price control. | Long-term, "set and forget" investors making regular monthly contributions. |
| ETFs (Exchange Traded Funds) | Index Funds (Mutual Funds) | ||
|---|---|---|---|
| Pros | Cons | Pros | Cons |
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Which is Best for You? The Deciding Factor is How You Invest.
For most UK investors, the choice between an ETF and an index fund that tracks the same index (e.g., a FTSE 100 ETF vs. a FTSE 100 index fund) comes down to one simple question: How are you planning to invest?
If you plan to invest regular monthly amounts (e.g., £100 per month from your salary): An index fund is almost always the better choice. The lack of dealing fees means every penny of your £100 goes to work, without being eroded by a £5-£12 trading charge each month. This makes it the ideal vehicle for "drip-feeding" and pound-cost averaging.
If you are investing a larger lump sum (e.g., £10,000): An ETF can be a great choice. The single dealing fee becomes a very small percentage of the total investment, and you may benefit from a slightly lower ongoing charge. It also gives you precise control over the price you buy at.
Ultimately, both are excellent, low-cost tools for building a diversified portfolio. For a long-term investor, the differences are minor compared to the most important decision of all: simply starting and staying invested.
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Disclaimer: This guide provides general information about ETFs and index funds and is for informational purposes only. It does not constitute financial advice. The value of investments can go down as well as up, and you may get back less than you invested. Past performance is not a reliable indicator of future results. Tax treatment depends on individual circumstances and may be subject to change. Always consider seeking independent financial advice before making any investment decisions.