Index Fund
Definition
A mutual fund or ETF that passively tracks a specific market index (like the S&P 500) by holding all or a representative sample of the index's securities.
An index fund is designed to replicate the performance of a market index rather than trying to beat it. When you invest in an S&P 500 index fund, you own a proportional slice of all 500 companies in that index. This passive approach was popularized by Vanguard founder John Bogle in 1976.
The evidence overwhelmingly supports index investing. Over 15-year periods, approximately 90% of actively managed funds fail to beat their benchmark index after fees. The combination of lower fees and consistent market-matching returns makes index funds the foundation of most financial advisors' recommendations.
Index funds come in two formats: mutual funds (purchased at end-of-day NAV) and ETFs (traded throughout the day). Both achieve the same goal — tracking an index — but differ in how you buy them and their tax treatment. The most popular include Vanguard Total Stock Market (VTI/VTSAX), S&P 500 (VOO/VFIAX), and Total International (VXUS/VTIAX).
Portfolio construction with index funds typically follows a simple approach: decide your stock/bond allocation based on risk tolerance and time horizon, then fill each bucket with broad index funds. A "three-fund portfolio" (US stocks, international stocks, US bonds) provides global diversification at minimal cost.
The main limitation of index investing is that it guarantees you'll never beat the market — you'll match it minus small fees. For most investors, this is perfectly acceptable, especially considering that most attempts to beat the market through active management also fail after fees.
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Frequently Asked Questions
Are index funds good for beginners?
Yes, index funds are widely considered the best starting point for new investors. They provide instant diversification, have very low fees, require no stock-picking expertise, and have historically generated strong long-term returns. Warren Buffett has recommended S&P 500 index funds for most investors.
What's the minimum to invest in an index fund?
ETF index funds can be purchased for the price of a single share (many brokerages now offer fractional shares for as little as $1). Mutual fund index funds may have minimums of $1,000-$3,000, though some brokerages have lowered or eliminated these.