Back to glossary
Account & Regulation

Index Fund

A mutual fund or ETF designed to track a specific market index, such as the S&P 500. Low fees, broad diversification, and historically better long-term returns than most actively managed funds.

What is an index fund?

An index fund is a mutual fund or ETF that owns the same stocks (or bonds) as a market index in roughly the same weights. Instead of a human manager picking winners, the fund automatically mirrors the index. The result is low cost, predictable behavior, and returns that closely match the overall market.

Key features

  • Low expense ratios: major index funds charge fractions of a percent annually, versus 0.5% to 1.5% for actively managed funds. Over decades, the fee difference compounds into a significant chunk of returns
  • Broad diversification: buying one fund can give you exposure to hundreds or thousands of companies
  • Tax efficient: low turnover means fewer taxable capital gains distributions
  • Transparent: the holdings are known because they match a published index
  • Passive: no attempt to beat the market, just to match it

Popular index funds

  • S&P 500 funds: VOO, IVV, SPY, SWPPX, VFIAX. Track the 500 largest US companies. See S&P 500
  • Total US market funds: VTI, ITOT, VTSAX. Track essentially every investable US stock
  • International funds: VXUS, IXUS. Track developed and emerging markets outside the US
  • Bond funds: BND, AGG. Track the broad US bond market
  • Nasdaq-100 funds: QQQ, QQQM. Track the 100 largest non-financial Nasdaq stocks. See NASDAQ

Why they work

Most actively managed funds underperform their benchmark index over long periods, after fees. Index funds guarantee you will match the market (minus a tiny fee), which in the long run tends to beat most active managers.

For long-term investing, a handful of low-cost index funds covering US stocks, international stocks, and bonds is a proven recipe that has outperformed most professional stock pickers.

Related Terms

Certificate of Deposit

A time deposit at a bank or credit union that pays a fixed interest rate for a set term. FDIC-insured up to the standard limit and lower risk than most investments, but with early withdrawal penalties.

ETF (Exchange-Traded Fund)

A fund that trades on an exchange like a stock, holding a basket of assets such as stocks, bonds, or commodities. SPY and QQQ are ETFs.

Money Market Fund

A type of mutual fund that invests in short-term, low-risk debt like Treasury bills and commercial paper. Used as a cash-equivalent place to park money with a higher yield than a typical bank account.

Mutual Fund

A pooled investment fund managed by a professional that buys a portfolio of stocks, bonds, or other assets. Investors buy shares of the fund, not the individual holdings.

NASDAQ

The second largest stock exchange in the world, fully electronic with no physical trading floor. Known as the home of technology stocks.

REIT

A Real Estate Investment Trust: a company that owns income-producing real estate and trades like a stock. Required to pay out at least 90% of taxable income as dividends, which makes REITs popular for income investors.