Why index funds are a smart choice for long-term investors

What if you could grow your wealth, avoid stock-picking stress, and beat most professional investors?

Over the past 20 years, index funds outperformed 93% of U.S. active funds. It’s a surprising stat, as active funds usually charge higher fees for the privilege.
Index funds are much simpler (and more powerful) than you might think. Let’s take a closer look at how they work and how to find the right one for you.

WHAT IS AN INDEX FUND?
If you’re looking to invest in the stock market, but don’t want to spend hours figuring out which companies to buy into, an index fund gives you a ready-made selection of stocks. It allows you to invest in a range of companies all at once.

The “index” part just means the fund tracks an index or list, for example the top 100 companies in the UK, known as the FTSE 100. The goal is to mirror the returns of the whole list, rather than beat it or pick favourites.

Sometimes the fund holds all the companies on the list (e.g. all 500 in the S&P 500) or it holds a carefully chosen sample that closely matches the index’s performance.

A traditional index fund, the kind you might buy in a pension or ISA, is priced once a day. An ETF (Exchange-Traded Fund) is a type of index fund that works more like a share, which means you can buy and sell it throughout the day, just like a single stock.

If you’re a long-term investor, it doesn’t really matter which you pick, but if you want more flexibility ETFs give you that.

The main benefits of index funds are the following.

• Low-cost: You’re not paying a manager to predict stock movements.
• Low-stress: You don’t need to pick winners as you get returns on the whole market.
• Consistent: Over time, most active managers don’t beat the index. So index funds often do better and cost less over the long-term.

Even Warren Buffett recommends index funds for most people. He said that when he’s gone, he wants 90% of his money to go into an S&P 500 index fund – that’s how much he trusts them!

INDEX FUNDS GIVE YOU INSTANT DIVERSIFICATION
Diversification means spreading your money out, instead of putting it all in one place.

For instance, if you fail to diversify your investments and pick one or two companies that have a terrible year, your money has a terrible year too. On the other hand, if you invest in 500 companies at once with an index fund, then a few bad apples won’t spoil the whole basket.

Index funds do the diversification for you. A single fund exposes you to hundreds of companies, or thousands if it’s a global index fund. It’s the variety of an index fund that helps protect you, as if one company crashes, the others help steady your portfolio.

An index fund lets you diversify in a few different ways.

• Geographically: For example, UK-only vs Global or Emerging Markets.
• By sector: Tech, healthcare, energy, real estate, etc.
• By size: Large-cap (big companies) vs mid-cap or small-cap.

Another appealing thing about index funds is that you don’t have to do too much maintenance, as you can set them up to automatically rebalance and reinvest.

• Rebalancing: Adjusting the mix of investments so you’re not accidentally taking on too much risk.
• Reinvesting dividends: Any income your investments earn gets put back in, helping your money grow even faster over time.

The market will always have ups and downs, but jumping in and out based on emotion is a bad strategy. With their automated and passive style, index funds improve consistency because you’re not trying to time the market or chase performance.

The power of diversification can be seen in the 2025 flash crash. When markets dipped fast, the S&P 500 dropped nearly 20% in a matter of weeks. But the FTSE 100 only dropped about 10%. Why? Because the FTSE has a more diverse mix of stable, defensive companies (like banks and utilities) while the S&P is more tech-heavy, making it more sensitive to shocks and turbulence.

MORE MONEY IN YOUR POCKET OVER TIME
If you’re not careful, fees can quietly nibble away at your investment gains without you noticing. Whenever you invest in a fund, whether it’s active or passive, you pay a management fee every year which is usually a small percentage of your investment.

For actively managed funds, where a fund manager tries to beat the market by picking stocks, the fee is often around 1% or more. But with index funds, the fee can be as low as 0.10%, because you’re not paying someone to try and outsmart the market. The fund simply follows the index.

Even though it seems like only a tiny difference (0.9%) it adds up over the long run. Say you invest £100,000 over 30 years, and it grows at 8% a year.
With a 0.10% fee, you could end up with about £970,000.
But with a 1.00% fee, that drops to around £760,000.
That’s over £200,000 lost to fees, and many people don’t even realise it’s happening.
It’s called “fee drag” and it acts a bit like compound interest in reverse. The worst part is, the fee comes out whether the fund does well or not.

The reason active funds charge a larger fee is because you’re paying for someone to try and beat the market by researching companies, analysing data, and placing trades, which makes it labour-intensive.

BUILD WEALTH WITH LESS STRESS
Index funds track the market, without trying to beat it. This makes them more predictable.

“Predictable” doesn’t mean you’ll always make money. It means they follow the market’s ups and downs closely, so you know what you’re getting – slow, steady growth over time.

According to S&P Dow Jones’ SPIVA report, 93% of U.S. large-cap active funds underperformed the S&P 500 over the last 20 years. In other words, people pay higher fees for worse results. Meanwhile, low-cost index funds quietly keep pace with the market, which is enough to win over time.

One of the best tactics for calm, predictable investing is “dollar-cost averaging”. It means putting in the same amount of money at regular intervals, no matter what the market is doing. For example, you put £100 per month into an index fund and forget about it. Over the long run, you benefit from the built-in index diversification and natural upward trend of the markets.

HOW TO CHOOSE THE RIGHT INDEX FUND FOR YOU
The best index fund for you depends on your personal situation, such as your goals, how long you want to invest, and how much risk you’re comfortable with.

Let’s start with your investment goals. Are you saving for retirement in 30 years? Or a house deposit in 5?

Long-term goals can ride out more ups and downs, which means you might choose a fund that focuses more on growth, like a global or S&P 500 index.

For shorter-term goals, you might want a mix that’s more stable, like a balanced fund that includes bonds.

In terms of risk, ask yourself how you’d feel if your investment dropped 20% next month. If that idea makes you sweat, then stick with broader, more conservative funds, maybe something like the FTSE 100 or a global fund with a bit of everything.

If you’re okay riding out the dips for long-term growth, then an S&P 500 index fund might be a better fit

If ethical investing is important to you, then look for ESG index funds now that filter out companies involved in things like fossil fuels, tobacco, gambling, or weapons. You can also find funds that prioritise clean energy, diversity, or social responsibility. Just check the fund’s fact sheet to see what it includes or excludes.

To summarise, the  best fund is the one you understand, feel good about, and can stick with. Don’t just chase last year’s top performer, as that changes all the time. Instead, focus on the following criteria.

• Low fees
• Broad diversification
• How well it fits your plan

MAKE IT TAX-EFFICIENT FROM THE START
Tax efficiency might not sound too exciting, but it makes a big difference over time. That’s   especially true with index funds, where you’re playing the long game.

Index funds generate returns in two ways – capital growth (when the value of the fund goes up) and dividends (when the companies inside the fund pay out profits). Outside of a tax wrapper, both of those can be taxed.

In the UK, you can be more tax efficient by investing in an index fund through an ISA or a SIPP.

• A Stocks and Shares ISA is a flexible, tax-free investment account. You can put in up to £20,000 per year, and you won’t pay any tax on growth or dividends from your index funds.
• A SIPP, or personal pension, is more long-term. The government adds to your contributions in the form of tax relief of 20 to 45%. This makes it a great way to boost your retirement savings.

Even a small portfolio can grow into something substantial over 10, 20, 30 years, and index funds are designed for exactly that kind of growth. Using an ISA to hold your index funds means more of your investment earnings are protected from tax.

SIMPLE DOESN’T MEAN BORING OR UNPROFITABLE
Many people assume that if something’s simple, it can’t be powerful. But when it comes to investing, that’s completely wrong. Some of the richest people in the world recommend index funds, even though they are the simplest way to invest.

The reason index funds are so powerful is that they are predictable and diverse. You also benefit from compound growth. Say you invest £10,000 and it grows at 8% a year. After 10 years, you’d have about £21,500. But after 30 years it would be worth over £100,000 without putting in another penny.

The people who build serious wealth aren’t the ones constantly switching things up. They’re the ones who stay consistent for 10, 20, 30 years. That’s the real secret and that’s why index funds are often the best choice for sensible investors.

If you need help deciding which index funds are right for you or setting one up, then get in touch today.