An index fund is an investment fund that aims to track the performance of a market index, such as the FTSE 100, rather than trying to beat it. It holds the index constituents in proportion, keeping costs low.
In one line: An index fund passively tracks a market index instead of trying to outperform it, which keeps its charges low.
How an index fund works
Index funds are collective investments regulated by the FCA. Because they follow a rule-based index rather than employing active stock-pickers, their ongoing charges are typically much lower than actively managed funds.
For example, 10,000 GBP in an index fund charging 0.10% a year costs 10 GBP in annual fees, against perhaps 75 GBP for an active fund charging 0.75%. Over decades that gap compounds significantly.
The fund's return mirrors the index minus charges and tracking error, so it will not beat the market but will not badly trail it either.
Index fund vs an ETF
An index fund is usually an OEIC or unit trust priced once a day. An ETF can also track an index but trades on an exchange throughout the day like a share.
Both can follow the same index cheaply; the difference is how they are bought, priced and held on a platform.
Primary source: FCA: Investing basics