Key takeaways
- An index fund tracks a market index, like the S&P 500, instead of trying to beat it.
- Low fees and broad diversification are the main advantages.
- Compare expense ratios; a small difference compounds over decades.
An index fund is a mutual fund or exchange-traded fund (ETF) that aims to match the performance of a market index. Instead of a manager picking stocks, the fund simply holds the companies in the index.
Why index funds work for most people
- Diversification: One fund can hold hundreds or thousands of companies, so one company’s bad year doesn’t sink you.
- Low cost: Because no one is paid to pick stocks, fees are low. Many broad index funds charge well under 0.10% a year.
- Strong long-term track record: Over long periods, most actively managed funds have trailed their benchmark index after fees.
- Simplicity: You don’t need to research individual companies.
Common types
| Index fund type | What it holds |
|---|---|
| S&P 500 | About 500 large U.S. companies |
| Total U.S. stock market | Nearly every publicly traded U.S. company |
| Total international | Companies in developed and emerging markets outside the U.S. |
| Total bond market | A broad mix of U.S. investment-grade bonds |
| Target-date fund | A mix of stock and bond index funds that gets more conservative over time |
Mutual fund or ETF?
Both can track the same index. ETFs trade throughout the day like stocks and often have no minimum beyond the price of one share (or less, with fractional shares). Index mutual funds trade once a day and may have minimum investments. In a retirement account, either works well.
How to choose
- Decide what you want to own: U.S. stocks, international stocks, bonds or a mix.
- Compare expense ratios. On a $100,000 balance, a 0.05% fund costs $50 a year; a 0.75% fund costs $750.
- Check what your 401(k) offers. Look for funds with “index” in the name or the lowest expense ratios.
- Keep it simple. Two or three funds, or one target-date fund, is enough for most people.
The risks
Index funds rise and fall with the market. A stock index fund can drop 20% or more in a bad year. They’re meant for money you won’t need for at least five years.
Ready to start? Read our beginner’s guide to investing.
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