The two main approaches you can take if investing your money this way are to invest for the long term, or to make short term trades in pursuit of faster profits. Keep reading for an explanation of both these approaches.
Investing (long term)
With this approach your aim is to invest your money for a number of years in an index that you think will increase over time. You can do this in a variety of ways, including trading ETFs, buying shares in the companies that make up the index, and putting your money in index funds for extended periods of time. These are the things you need to do if this is your chosen strategy:
- Analyse broad market trends. You want to invest in a stock index that will trend upwards into the future, and so the most important thing to do is conduct a fundamental analysis of the market. Each stock market will list different companies, and as a result you need to assess whether those businesses as a whole look set to grow over time – as this is what will push the index higher.
- Look for long term value. Tying into the point above, you want to ensure you’re investing in an index comprised of stocks that will generate consistent growth. As you’re investing for the long term, you don’t want to end up with an index that rises sharply but then proceeds to fall steeply because the companies it tracks have become overvalued.
- Think about how long you want to invest for. With any long term investment you run into what is known as ‘opportunity cost.’ This simply means that you can’t invest the same money in two things at once – therefore the money you invest in a stock index will be tied up in that investment until you sell it. Think about how long you want your money to be invested in this way so you can plan your future.
- Prepare for volatility. Stock markets typically fluctuate from day-to-day, and you want to do your best not to concern yourself with short term volatility. Your aim is for your investment to be worth more in a year than it is today, and just because it might drop a tiny bit tomorrow does not mean that won’t happen. Keep your focus on the long term.
- Be ready to change your approach. Stock indices are particularly prone to following overall market trends. When markets are rising it’s known as a bull market and this tends to send indices shooting up. However, if global markets start falling then a bear market can set in – this often causes investors to panic and sell their shares, which can lead to a stock index falling very quickly. If you see the signs of a bear market setting in, you will want to cash out your investment to protect your capital.
- Choose a reliable broker. Your broker acts as the middleman to help make your investments. As you will be trusting this platform with your money for the long term, you want to make sure you’re using a reliable service. Our reviews can help you find the right broker for investing in indices.
In order to give yourself the best chance of long term investment success, the most important thing to keep a cool head and make sure you’re always acting rationally. It’s easy to get caught up in the moment if an index starts to rise or fall quickly, which is why it’s important to do your research and keep your analysis in mind.
In the long run, indices are often some of the best-performing investments you can make. Despite it being a century that saw two World Wars and multiple market crashes, the 20th century saw the Dow Jones Industrial Average index rise by 5.3% compounded annually. Keeping an eye on the long term growth will help you ride out the brief storms.
Trading (short term)
The other approach you can take to investing in indices is to make short term trades. This tends to involve using easily tradeable ETFs and CFDs – buying and selling them quickly as the value of an index fluctuates. Here’s what you need to do when trying to profit from short term trades:
- Learn to read index charts. When trading, you want to be able to anticipate which way the market will move and react accordingly. The best way to do this is to read and analyse charts of an index’s past performance and spot trading patterns that are likely to repeat. This is a process known as technical analysis and is essential to trading.
- React quickly to events. Markets can move quickly, with stock indices often rising or falling quickly depending on global events. One example of this was on February 20th 2020 when indices around the world suddenly plunged due to growing concern about the coronavirus pandemic. If such an event is on the horizon, you want to get out quick before your trades go south.
- Focus on mitigating risk. While with each trade your focus is on the short term, the best traders are those that manage their risk over time. You won’t be right with every trade, and you want to ensure you put yourself in such a position to turn £100 into £110 if you’re right, but only to drop to £95 if you’re wrong.
- Keep calm and focussed. Prices are constantly moving up and down and it can be hard to keep your focus when things get particularly volatile – but this is when it’s most important you keep a cool head. You want all your trades to be based on solid research and analysis and to avoid getting caught up in the moment.
- Look for the right trading platform. You will need an online broker to place your trades, and the user experience, indices available, and fees are different depending on which platform you pick. Our reviews will help you find the best trading platform for your trades.
The most important thing to bear in mind is to stick to your trading strategy. By following a solid plan and making sure not to be distracted by market shifts, you give yourself the biggest change of success when trading indices.
It is also crucial to treat every profitable trade as a win, and not to feel like you’ve messed up if you sold before the price went higher. If you invest £70 and sell when that turns into £80, then you’ve made a £10 profit and a successful trade. Whether the index continues to climb to a point where you could have sold it for £90 is irrelevant – you made a profit that you can use to place more trades.
What is best for me?
The only person who can answer this question is you, and we’ve come up with this handy checklist to help you make the right choice.
- Read about the different major indices. You never want to invest in something you don’t understand, so take the time to research your options. Learn the different pros and cons of investing in each index, and have a firm idea of the different ways you can invest your money.
- Figure how much you want to invest. Your budget can be a determining factor in your investment approach. Long term investing is generally a better option if you’re looking to turn £1,000 into £10,000 over the course of many years – whereas if you have a few hundred pounds and you want to try and generate steady profits as extra income the trading is the way to go.
- Decide the level of risk you’re comfortable with. Generally it is safer to invest in an index long term than to make short term trades as the market fluctuates. The caveat here is that neither approach guarantees profits, and any investment should only be made with money you can afford to lose.
- Consider your timeframe. The amount of time you want your money to be tired up for will impact which strategy is best for you. With investing, you will not have access to your money for a longer amount of time as you leave it invested to grow in value. Whereas when trading you will constantly be buying and selling positions on different indices and so will always have access to your funds.
- Select your ideal platform. If you want to invest, you want a secure platform that allows you to buy and hold your investments to reap gains in the future. For trading you want to prioritise a broker that charges low fees and commissions and supports a range of trading options.
- Start investing gradually. Everyone makes mistakes, and beginners more than most. For this reason it’s sensible to start by investing or trading just a small amount and growing your position over time. For instance, if you have £500 and you want to invest, start with just £200 in one index and add an additional £100 each of the next three months as you gain confidence.
Of course, there is no reason why you can’t pursue both investing and trading at the same time. You might want to save for your future by investing some money in a prominent index such as the S&P 500 for the long term, but also want to use some of your money to place short term trades.
What to invest in, and ways to invest
There are a range of different ways to invest in indices, regardless of if your ambitions are long or short term. You can buy the stocks that an index tracks, invest in all of them at once using ETFs or mutual funds, or use financial instruments such as futures contracts to speculate on their value.
To help you navigate your options, keep reading to find out the different major indices you can invest in, and then a summary of the different ways to make your first investment.
What should I invest in?
There are thousands of stock indices around the world – with most exchanges having more than one index following different companies’ performance. Here are some of the world’s largest and most often-traded indices you might want to consider.
- FTSE 100. The Financial Times Stock Exchange 100 (FTSE 100) is an index that follows the performance of the top 100 stocks traded on the London Stock Exchange. It is one of the most influential indices in the world and serves as an indicator of the strength of the UK economy.
- S&P 500. Following the top 500 companies traded on stock exchanges across the USA, the S&P 500 aims to give an accurate picture of the economic outlook for businesses across North America.
- Dow Jones Industrial Average. Also known as the Dow Jones, or just as the Dow, this index is an example of a blue-chip stock index. This means that it follows only very well-established and valuable companies. The Dow Jones Industrial Average follows 30 of the best-performing companies in the USA, with the current components all trading either on the New York Stock Exchange or the Nasdaq.
- Nasdaq Composite. This index includes every single stock that trades on the Nasdaq stock exchange. The Nasdaq has a reputation for listing mainly highly valuable technology stocks, and the Nasdaq Composite is therefore a key indicator of the strength of the tech industry.
- DAX. Similarly to the Dow Jones, the DAX Performance Index is the main blue-chip index of Germany. Including 30 of the largest stocks that trade on the Frankfurt Stock Exchange, the DAX is closely tied to German economic performance.
- CAC 40. Measuring the performance of 40 of the top stocks trading on Euronext Paris, the CAC 40 is used as the benchmark index of the French economy. This makes it one of the most influential indices in Europe.
- Nikkei 225. Following 225 of the most valuable companies on the Tokyo Stock Exchange, the Nikkei 225 (or Nikkei for short) is a great option for investors looking to invest in the success of the Japanese economy.
- NIFTY 50. A key pillar of the Indian economy, the NIFTY 50 lists the 50 largest stocks that trade on the National Index. As an emerging economy, growth in businesses in India over the coming years could have the effect of pushing the NIFTY 50 to new heights.
These are just examples of the most famous indices in the world, and you can find out about hundreds of others – and find their recent price history – right here. For now, let’s move on to the different methods you can use to invest in indices.
Ways to invest
Once you have decided which index (or indices) you want to invest in, it’s important to consider the different options available through which you can do so – there’s not just one way to invest in an index. Here is a quick summary of each method you can use to invest.
- Indexing. This refers to the process of simply buying shares in all the companies tracked by a given index. This is only really a feasible approach for blue-chip indices that track a small number of stocks (e.g. the Dow or the DAX), as with larger indices you would have to complete a lot of stock purchases and this would rack up high fees.
- ETFs. Index ETFs (Exchange-Traded Funds) allow you to invest in all the stocks an index contains without having to buy them individually. An ETF can contain a number of assets (e.g. every stock tracked by the FTSE 100), and therefore allow you to invest in the performance of the index by making just one trade.
- CFD trading platforms. You can trade indices using instruments known as CFDs (Contracts for Difference). Using these you can essentially bet on which way you think an index will go – buying a CFD the index’s current price and then selling it later once its level has risen (in which case you make a profit) or fallen (in which case you make a loss).
- Mutual funds. You can invest in indices using mutual funds – and when you do so they’re usually referred to as index funds. A mutual fund is made up of a group of people who all invest money together, this money is then handed to a fund manager who chooses how to invest it with everyone sharing the profits. An index fund is a mutual fund structured so as to follow the performance of an index.
- Futures and options. Options and futures contracts allow you to agree the terms of trades to be made in the future. The difference between the two is that options do not require you to make the trade whereas futures do. For example, if you believed the level of an index would rise from 6,500 to 6,600 by next week you could make an agreement to buy it at 6,550 on the following Monday. With a futures contract, you would have to buy it at that level whatever the price, and with an option you could choose not to make the trade if the index had failed to rise as expected.
- ISAs. If you want to save for your future you can invest in an index using an ISA. These are Independent Savings Accounts that allow UK citizens to save and invest £20,000 a year tax-free. There are a variety of index-linked ISA options if you want to generate wealth for retirement or a large purchase like a house.
- Robo-advisors. A popular new way of investing using technology, robot-advisors usually take the form of apps which will invest your money for you using parameters you set. You can choose for your robo advisor to invest your money in different indices and index funds in order to grow your capital for the future.
- Trusts. Trusts operate like mutual funds, but they are incorporated as companies. A trust might link its performance to a specific index, or invest in a range of indices, and you can buy shares in it in order to benefit from the growth of these indices.
What now?
Now you have a grasp on how to invest in indices, we recommend following some of the links at the top of this page to make your first investment or learn more. Alternatively, keep scrolling down for the best brokers to use, along with the latest news and analysis from our team.
