Index Fund
An index fund is a mutual fund or ETF designed to track the performance of a specific market index (like the S&P 500) by holding the same securities in the same proportions, offering broad diversification with low fees.
Exam Tip
Index funds = PASSIVE management, LOW fees, track a BENCHMARK. Most active managers fail to beat indexes long-term.
What is an Index Fund?
An index fund is a type of mutual fund or ETF that aims to replicate the performance of a specific market index by holding all (or a representative sample) of the securities in that index. This passive investment strategy provides broad market exposure with minimal management.
How Index Funds Work
| Component | Description |
|---|---|
| Benchmark | Tracks a specific index (S&P 500, Total Stock Market, etc.) |
| Holdings | Owns securities in same proportion as index |
| Management | Passive - no stock picking |
| Goal | Match index performance, not beat it |
Popular Index Funds Track These Benchmarks
| Index | What It Represents |
|---|---|
| S&P 500 | 500 largest U.S. companies |
| Total Stock Market | Entire U.S. stock market |
| Russell 2000 | Small-cap stocks |
| MSCI EAFE | International developed markets |
| Bloomberg Aggregate Bond | U.S. investment-grade bonds |
Index Funds vs. Actively Managed Funds
| Factor | Index Fund | Active Fund |
|---|---|---|
| Management | Passive | Active stock picking |
| Expense Ratio | 0.03% - 0.20% | 0.50% - 1.50% |
| Goal | Match market | Beat market |
| Turnover | Low | Higher |
| Tax Efficiency | Higher | Lower |
| Performance | Market returns | Varies widely |
Key Benefits of Index Funds
| Benefit | Explanation |
|---|---|
| Low Costs | Minimal management fees |
| Diversification | Own hundreds or thousands of stocks |
| Consistency | Performance mirrors the market |
| Tax Efficiency | Less trading = fewer taxable events |
| Simplicity | No need to pick individual stocks |
The Case for Index Investing
Studies consistently show that most actively managed funds underperform their benchmark index over time, especially after fees:
- Over 15 years, approximately 90% of active large-cap funds underperform the S&P 500
- Lower fees compound significantly over decades
- Warren Buffett recommends index funds for most investors
Types of Index Funds
| Type | Key Difference |
|---|---|
| Mutual Fund | Priced once daily, may have minimums |
| ETF | Trades throughout day like stock |
Exam Alert
Index funds are PASSIVELY managed with LOW expense ratios. They don't try to beat the market—they try to MATCH it. Know that most active managers underperform indexes over time.
Study This Term In
Related Terms
Mutual Fund
SecuritiesA mutual fund is a professionally managed investment vehicle that pools money from multiple investors to purchase a diversified portfolio of securities.
ETF (Exchange-Traded Fund)
SecuritiesAn ETF is an investment fund that trades on stock exchanges like individual stocks, typically tracking an index with lower fees than mutual funds.
Diversification
GeneralDiversification is an investment strategy that spreads investments across various assets, sectors, or geographic regions to reduce risk without necessarily sacrificing returns.