Index funds and ETFs are the most widely recommended investment vehicles for most UK savers — and for good reason. They offer instant diversification across hundreds or thousands of companies, charge very low annual fees, and remove the need to pick individual stocks or trust a fund manager to beat the market. Research consistently shows that the majority of active managers fail to outperform a cheap index over the long run.
This hub brings together all PocketWise content on passive investing: how index funds and ETFs differ, which indexes to consider, how costs work, where to hold them tax-efficiently, and how to build a simple long-term portfolio. For choosing where to hold these investments, use the Investment Platforms hub.
Key Tax Numbers for Investors in 2026/27
| Allowance | 2026/27 amount | Notes |
|---|---|---|
| Stocks and Shares ISA allowance | £20,000/year | Tax-free gains and dividends permanently |
| Annual pension allowance | £60,000/year | With tax relief on contributions |
| Capital Gains Tax exempt amount | £3,000/year | Above this, CGT applies on GIA gains |
| Dividend allowance | £500/year | Above this, Dividend Tax applies on GIA holdings |
| Personal Savings Allowance (basic rate) | £1,000/year | On cash savings interest |
The ISA wrapper is the first priority for index fund investors. Gains inside an ISA are permanently free of CGT and Dividend Tax, no matter how large the pot grows.
ETF vs Index Fund — Which Is Right for You?
| Feature | ETF | Traditional Index Fund |
|---|---|---|
| How it trades | Like a share, throughout the day | Once per day (end of day pricing) |
| Platform availability | Most platforms, including apps | Fewer platforms (fund supermarkets) |
| Minimum investment | Often can buy fractional shares | Fund minimum applies (often £1–£100) |
| Regular investing | Possible on most platforms | Often easier via direct debit |
| Ongoing charges | Often 0.05–0.20%/year | Often 0.10–0.22%/year |
| Tax treatment | Same as index fund | Same as ETF |
For most investors making monthly ISA contributions, the difference is minimal. Platform availability and ease of regular investing usually determine the better choice.
Worked Example: Cost of Active vs Passive Over 20 Years
Scenario: James invests £500/month for 20 years. The market returns 7%/year gross.
| Fund type | Annual fee | Final pot (approx) | Fees paid over 20 years |
|---|---|---|---|
| Global index ETF | 0.15% | £244,000 | ~£9,000 |
| Active managed fund | 1.00% | £221,000 | ~£32,000 |
| Active managed fund | 1.50% | £208,000 | ~£45,000 |
The difference between 0.15% and 1.50% is over £36,000 in final wealth — purely from the fee drag. And this assumes the active fund matches the index return, which most do not.
Which Index Should You Track?
| Index | Geographic coverage | Number of holdings | Best for |
|---|---|---|---|
| FTSE 100 | UK large companies | 100 | UK-focused investors |
| FTSE All-Share | UK large, mid, small companies | ~600 | Broader UK exposure |
| MSCI World | 23 developed markets | ~1,500 | Global developed market exposure |
| FTSE All-World | Developed + emerging markets | ~4,000 | Maximum global diversification |
| S&P 500 | US large companies | 500 | US market focus |
| MSCI Emerging Markets | Developing economies | ~1,400 | Emerging market tilt |
For a simple one-fund portfolio, a global developed market tracker (MSCI World or FTSE All-World) is the most common starting point. It provides exposure to thousands of companies across many economies, automatically rebalancing as markets shift.
Building a Simple Passive Portfolio
The simplest evidence-based approach for most investors:
| Portfolio complexity | Structure | Suitable for |
|---|---|---|
| One-fund | Single global index fund or ETF | Most long-term investors |
| Two-fund | Global developed + emerging markets | Slightly more emerging markets exposure |
| Three-fund | Global + emerging + UK | Adds home bias to global base |
Complexity beyond three funds rarely improves outcomes for most investors and adds rebalancing work. Start simple, stay consistent.
Wrapper Priority Order for Index Fund Investors
- Stocks and Shares ISA — use up to £20,000/year; gains and dividends permanently tax-free
- Pension/SIPP — for retirement capital; contributions attract tax relief of 20%–45%
- Junior ISA — if investing for children (£9,000/year limit)
- General Investment Account — only once ISA and pension allowances are used
Related Hubs
- ISAs hub — tax wrapper rules, Cash ISA vs Stocks & Shares ISA
- Investment Platforms hub — where to hold index funds cheaply
- Savings Accounts hub — cash alongside investment portfolio
The Index Funds and ETFs Cluster
- Index Fund Investing Guide
- Index Funds Explained UK
- Best ETFs for UK Investors
- Tracker Funds vs Index Funds UK
- Index Funds vs Actively Managed Funds UK
- Ethical Investing Guide
- Dividend Investing Guide
Common Passive Investing Mistakes to Avoid
Passive investing is simple, but the simplicity is deceptive. The most costly mistakes are behavioural, not technical:
- Selling during a market fall — index funds recover over time; panic selling locks in losses permanently
- Chasing last year’s top performer — past performance does not predict future returns; this applies equally to index funds that tracked a hot sector
- Holding cash “until things calm down” — time in the market beats timing the market for most investors; money sitting in cash misses recovery periods
- Ignoring rebalancing — if equities rise significantly, your portfolio becomes more equity-heavy than intended; annual rebalancing restores your target risk level
- Paying too much in platform fees — a 0.75% platform fee is more damaging than any fund-selection decision; use the cheapest platform compatible with your investing style