Index Investing — The Passive Approach
Why Warren Buffett told his estate to put 90% here
What Index Investing Is
An index is a list of companies selected by rules — usually by market capitalisation. The S&P 500 is the 500 largest US companies by market cap. The FTSE 100 is the 100 largest UK-listed companies. An index fund or ETF simply buys all of them in proportion, tracking the index mechanically.
Index investing means owning the market rather than trying to beat it. You accept the market's return, minus a very small fee. The thesis is that this approach outperforms most active strategies over time.
The Buffett Bet
In 2007, Warren Buffett bet $500,000 that a simple S&P 500 index fund would outperform a curated selection of hedge funds over 10 years. Protégé Partners accepted. After 10 years, the index fund returned 125.8%. The hedge funds averaged 36.3%. Buffett won by a wide margin.
In his 2013 letter to Berkshire Hathaway shareholders, Buffett wrote that the instructions for the trustee managing his wife's inheritance were: "Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund."
"The goal of the non-professional should not be to pick winners — neither he nor his 'helpers' can do that — but should rather be to own a cross-section of businesses that in aggregate are bound to do well."
Why Costs Matter So Much
A 1% annual fee versus a 0.07% annual fee sounds trivial. Over decades, the difference is enormous.
Illustrative only. Assumes consistent 8% gross return. OCF = Ongoing Charges Figure.
Which Index?
| Index | Coverage | Example fund |
|---|---|---|
| S&P 500 | 500 largest US companies | Vanguard S&P 500 ETF (VUSA) |
| FTSE All-World | ~4,000 companies, 90%+ of world market cap | Vanguard FTSE All-World (VWRL) |
| MSCI World | ~1,500 large/mid cap in 23 developed countries | iShares Core MSCI World (IWDA) |
| FTSE 100 | 100 largest UK-listed companies | iShares Core FTSE 100 (ISF) |
| MSCI Emerging Markets | ~1,400 companies in 24 emerging markets | Vanguard FTSE EM ETF (VFEM) |
For most long-term investors starting out, a single global all-world fund covers the entire investable world in one product at very low cost.
FAQs
Is index investing just settling for average?
The "average" return of the index beats the majority of professional fund managers after fees. What looks like settling is actually outperforming most active investors.
What if the whole market falls?
A global index falls too. This is unavoidable with market-wide exposure. The answer is time horizon — no 20-year rolling period in S&P 500 history has produced a negative return.
Can I do this inside an ISA?
Yes, and you should. Index ETFs are available inside Stocks and Shares ISAs on every major UK platform. All returns are then tax-free.
How often should I invest?
Monthly contributions on a fixed schedule (pound cost averaging) removes the temptation to time the market and builds the habit systematically.
Accumulation or income share class?
If you are building wealth and do not need income, accumulation class automatically reinvests dividends — more tax-efficient outside an ISA.
Key takeaways
- Index funds track a rules-based list of companies, giving broad market exposure at very low cost.
- Warren Buffett's estate instructions: 90% in an S&P 500 index fund.
- Over 20 years, 94% of active funds underperform their benchmark index after fees.
- A 1.5% fee vs 0.07% can cost tens of thousands of pounds over a 30-year horizon.
- A single global all-world fund covers ~4,000 companies across the entire investable world.