UK Index Fund vs Active Fund (2026/27)
Index funds vs active funds in the UK for 2026/27: what the FCA found on performance after fees, how charges compound, and how fund returns are taxed.
Index funds track a market; active funds pay a manager to try to beat one. This guide sets out what the FCA found when it studied UK fund performance, how charges compound over time, and how fund returns are taxed in 2026/27. It is general information, not a recommendation of any fund or provider. The value of investments can fall as well as rise.
What the FCA found
The FCA's Asset Management Market Study (final report, June 2017) looked at fund performance and the link between price and performance. Its findings (paragraphs 1.7 to 1.13):
- On average, both actively managed and passively managed funds did not outperform their own benchmarks after fees.
- There was no clear relationship between charges and the gross performance of UK retail active funds, and some evidence that higher charges went with worse net returns.
- It is difficult for investors to identify outperforming funds, and past performance is not likely to be a good guide to future performance.
- The FCA said its findings did not mean passive funds were preferable to active ones; investors should understand the total cost and the fund's objectives.
How charges compound
Illustration: £100,000 invested once, growing at 5% a year before charges, with the annual charge taken from the fund value each year. Both funds have exactly the same performance before charges. The rates are assumptions chosen to show the arithmetic, not typical market charges or a forecast.
| Years | 0.2% a year | 1% a year | Difference |
|---|---|---|---|
| 10 | £159,661 | £147,314 | £12,347 |
| 20 | £254,916 | £217,015 | £37,901 |
| 25 | £322,104 | £263,398 | £58,706 |
| 30 | £407,001 | £319,694 | £87,307 |
The FCA warns that charges and fees "can mount up over time, eating into your investment returns" (FCA InvestSmart). Compare the fund's ongoing charge and the platform's fee together, because you pay both.
Choosing between them
- Know what you are buying. A fund's objective tells you what it is trying to do; a tracker's index tells you exactly what it holds.
- Compare total cost. The FCA found many investors were not aware of the charges they pay.
- Diversify. The FCA notes that funds let you spread money across many investments and countries, which can smooth out returns but does not remove risk (FCA InvestSmart).
- Take a long view. The FCA suggests a timeframe of at least five years.
Tax on fund returns in 2026/27
- ISA or pension. No UK tax on income or gains inside an ISA (up to £20,000 paid in a year across all ISAs) or a pension (GOV.UK).
- Dividend distributions outside a wrapper: the first £500 is covered by the dividend allowance, then 10.75% (basic rate), 35.75% (higher rate) or 39.35% (additional rate) (GOV.UK).
- Accumulation units. Reinvested income is a notional distribution, taxable in the year, and added to your base cost for Capital Gains Tax (HMRC CG57707).
- Selling. Gains above the £3,000 annual exempt amount are taxed at 18% within the basic-rate band and 24% above it.
Related guides
- How to start investing - the steps before choosing a fund.
- Robo-adviser vs DIY index investing - management vs cost.
- Stocks and Shares ISA provider comparison - platform fees.
- ISA strategy - using the allowance.
Frequently asked questions
What is the difference between an index fund and an active fund?
An index (tracker) fund follows the rules of a market index and holds what the index holds, so there is no manager choosing investments. An active fund has a manager who chooses investments to try to beat a benchmark. Active funds usually charge more for that research and management. Both can be held in an ISA, a pension or an ordinary account.
Do active funds beat index funds?
On average, no. The FCA's Asset Management Market Study (2017) found that, on average, both actively and passively managed funds did not outperform their own benchmarks after fees. It found no clear link between what a UK active fund charges and its performance before fees, some evidence that higher charges go with worse returns after fees, and that it is hard for investors to identify outperforming funds in advance.
Does the FCA say passive funds are better?
No. The FCA said that reading its findings as a preference for passive over active funds would be wrong. Its point was that investors should understand the total cost of investing and the objective of the fund they buy, so they can choose the product that best meets their needs. Some active funds do beat their benchmark over a given period; the difficulty is knowing which ones beforehand.
How much difference do fund charges make?
Charges are taken every year, so the gap compounds. In our illustration, £100,000 growing at 5% a year before charges is worth £322,104 after 25 years with a 0.2% annual charge and £263,398 with a 1% charge: £58,706 less, on identical performance. This is arithmetic, not a forecast.
How are funds taxed in the UK?
Inside an ISA or a pension there is no UK tax on income or gains. Outside them, dividend distributions above the £500 dividend allowance are taxed at 10.75%, 35.75% or 39.35% in 2026/27, and gains above the £3,000 annual exempt amount at 18% or 24%. Income reinvested in accumulation units is still taxable each year.
Are accumulation units taxed if I receive nothing?
Yes, outside an ISA or pension. With accumulation units the income is reinvested in the fund instead of being paid out, but HMRC treats it as a notional distribution that is taxable in your hands. Because you have been taxed on it, the amount is added to your cost when you work out the gain on selling the units (HMRC Capital Gains Manual CG57707). Keep the annual tax vouchers.