On Christmas Eve, an unnamed narrator and some of his friends are gathered around a fire. One of them, Douglas, reads a manuscript written by his sister's late governess. The manuscript tells the story of her being hired by a man who has become responsible for his young niece and nephew following the deaths of their parents. He lives mainly in London and has a country house in Bly, Essex.
The boy, Miles, is attending a boarding school, while his younger sister, Flora, is living in Bly, where she is cared for by Mrs. Grose, the housekeeper. Flora's uncle, the governess's new employer, is uninterested in raising the children and gives her full charge, explicitly stating that she is not to bother him with communications of any sort. The governess travels to Bly and begins her duties.
Miles returns from school for the summer just after a letter arrives from the headmaster, informing his caretakers that he has been expelled. Miles never speaks of the matter, and the governess is hesitant to raise the issue. She fears there is some horrible secret behind the expulsion, but is too charmed by the boy to want to press the issue.
Soon after, around the grounds of the estate, the governess begins to see the figures of a man and woman whom she does not recognize. The figures come and go at will without being seen or challenged by other members of the household, and they seem to the governess to be supernatural. She learns from Mrs. Grose that the governess's predecessor, Miss Jessel, and another employee, Peter Quint, had had a close relationship. Before their deaths, Jessel and Quint spent much of their time with Flora and Miles, and the governess becomes convinced that the two children are aware of the ghosts' presence and influenced by them.
Without permission, Flora leaves the house while Miles is playing music for the governess. The governess notices Flora's absence and goes with Mrs. Grose in search of her. They find her on the shore of a nearby lake, and the governess is convinced that Flora has been talking to the ghost of Miss Jessel. The governess sees Miss Jessel and believes Flora sees her as well, but Mrs. Grose does not. Flora denies seeing Miss Jessel and begins to insist that she will not see the new governess again.
The governess decides that Mrs. Grose should take Flora away to her uncle in attempt to escape Miss Jessel's influence. Left alone with the governess, Miles at last confesses he was expelled for something he said but cannot remember what he said or to whom he said it. The ghost of Quint appears to the governess at the window. The governess shields Miles, who attempts to see the ghost. The governess insists to Miles he is no longer controlled by the ghost, only to find that Miles has died in her arms.
