Fun with Funds- An Intro to Index Fund Investing

How I'm saving for my new daughter's future- Part 3:Index Funds

Fun with Funds

This is the third and final part of my series explaining how I'm saving for my new daughter's future.

If you haven't yet taken a look, it would be worth reading through the first two before diving in here.

Part 1: Compound Interest- What's so interesting about interest?
Part 2: Risk vs Return- Probabilities and Peanut Butter

Here's the conundrum. I want to get a better return on my money, but I want to minimise the risk of losing it all. I want to make the best possible choice for my investment.

Photo by from Pexels

It's helpful to break investing down step by step. The more technical terms have been explained as we go through.


One way of investing is to buy shares.  You could choose to buy shares in a company. 

Shares are a bit of the company that you own. You have a share in it. You therefore would have a right to any money they pay out (dividends).This also means if the company does well, then your shares increase in value and are worth more. However if the company does poorly or even goes bust, you could lose your money.

Because of this risk, a lot of people choose to buy shares in several different companies, this means if one does badly, it may be that the others do better, and they cancel out. This is less risky. Imagine buying shares in Facebook, Amazon and Toys'R'Us ten years ago. Although you'd have lost a lot of money on Toys'R'Us the others are likely to have made up for it and you'd be doing well overall.


Taking this approach further is to invest in a fund. In a fund, someone has chosen a whole load of shares, in different companies and created a bit of a mix, the idea being that it spreads the risk out. 

A fund manager will look after the fund and choose which shares to invest in. They use powerful data analysis and their expert judgement to make these decisions. These fund managers charge a fee for their services and it means that any money you make will have a cut taken from it. Again if the fund does badly, you could lose out, but its generally less risky than individual shares.

There are loads of different options for funds, and you don't have to just choose one, you can choose multiple funds and spread out the risk even more. 

The problem with a lot of funds is that they very much depend on the skills (and luck!) of the fund manager. And because these funds charge fairly high fees, it means that potential earnings become limited.

There is another solution, which is becoming more and more popular. A particular type of fund called an index fund.

Index Funds

An index fund is a fund- it holds shares in all sorts of different companies. What makes it different to the funds explained above, is that there is much less input from a fund manager. An index fund simply tries to match the performance of a particular index.

Think of those bits of the news where you stop paying attention. The financial bit that tells you what's going on in the economy. "The FTSE100 is up 3 points at...." "The Dow Jones is down 2 points at....."  These are both examples of an index. The FTSE100 is 100 big companies in the UK. If they do well, the index goes up. If they do badly the index goes down. (The Dow Jones is similar for 30 companies in the USA).

What an index fund does is mirror the index through the shares that it buys. If the FTSE100 goes up, so does the fund. If it goes down, guess what, so does the fund.  However since the FTSE100 is made up of some of the largest companies in the UK (Like Tesco, Marks and Spencer, Lloyds, Rolls Royce, Shell), it's much less likely that it will drop significantly. And any drops tend to iron out over time.

Have a look at this graph to illustrate:

What it shows is the movement in the FTSE100 over time. Now, as you can see there are lots of ups and downs, dips such as the financial crash in 2007-2009 stands out, as does the Dot-Com bubble popping just after the millennium. 

Now, whilst the past is no guarantee over the future, you can see that overall the general trend is very much upwards. Over the years and years that my daughter Gertrude has until adulthood, these peaks and dips are likely to iron out and lead to growth. But how much growth?

Well, a conservative average for the past 20-30 years shows annual growth of around 5-6%. Now that might not sound like a lot, but compared to 1% in a savings account it sounds pretty good to me. Putting £1,000 in and leaving it for 20 years gives over £3,000 at the end, compared to just £1,200 at 1% (See my article on compound interest  for more details).

That's some serious gains for a little effort.

The absolutely crucial part is to stick at it for the long term. The longer the better. We're talking 5 years plus. Anything less than that and you may not have time to ride out the dips and benefit from the peaks. 

If you're prepared to invest for the long haul, and want a low risk way of doing it, then an index fund is worth looking at.

There are plenty of different ways to do this. I do my investing through a stocks and shares ISA, it means that your income and gains are tax free which is just lovely jubbly.

What should you do?

That’s up to you. It largely concerns your attitude to risk. This is not me advising you to do the same thing as I did. However, it might be worth investigating further, particularly if you are just dropping money into a  savings account.

Let's be clear, this isn't me telling all readers of doughmoneyblog that you should invest your life-savings into index funds. It's an encouragement to look a bit deeper, read a bit more, and consider whether leaving money gathering dust somewhere is really the best option. Please don't go and make any decisions based on this post alone. Please do go an look in more depth. I've given a couple of useful websites below for further reading.

Like I said before, look in more depth. Consider more options. Educate yourself as to what is out there. Be proactive with your money. It will make a huge difference over the years to come.

Helpful Articles:

Money Saving Expert:
Motley Fool:

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