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An index fund is a fund that owns every stock in a particular list, in the same proportion. An S&P 500 index fund, for example, owns all 500 of those companies. There is no manager picking winners. The fund just buys what is on the list.
Why this is a big deal
Studies have repeatedly shown that over 10- and 20-year periods, the large majority of professional fund managers fail to beat their benchmark index, once you account for their fees.
Indexing skips the manager entirely. No expensive research team. No star manager salary. Just the cheapest possible way to own a piece of the broader market.
What you actually get
- Diversification: owning hundreds or thousands of companies at once.
- Low cost: fees often under 0.05% per year.
- Tax efficiency: especially in ETF form.
- Simplicity: no need to read earnings reports or pick stocks.
What it does not get you
It will not beat the market. By design, an index fund matches the market minus a tiny fee. If you want to outperform, you have to take a different bet, and most people who try, lose to indexing in the long run.
What this lesson is NOT
An index fund owns the market, so by design it will not beat the market; it returns close to the average, minus a tiny fee. This lesson is the case for that trade, not a promise that the market only rises or a claim that indexing wins in every single year.
Frequently asked questions
What is an index fund?
An index fund is a mutual fund or ETF that tracks a specific market index (like the S&P 500) by holding the same stocks in the same proportions. Instead of trying to pick winners, it holds everything in the index. This makes them low-cost, tax-efficient, and historically very hard for active fund managers to beat over long periods.
Are index funds better than actively managed funds?
Over long periods, the data strongly favors index funds for most investors. Studies repeatedly show 80-90% of active fund managers underperform their benchmark over 10-15 year periods, largely due to fees. The fees on index funds are typically 0.03-0.20% per year vs. 0.50-1.50% for active funds. That gap compounds enormously over decades.
What's the difference between an ETF and a mutual fund?
Both can be index funds. ETFs (exchange-traded funds) trade like stocks throughout the day and typically have lower minimums. Mutual funds price once daily after market close and may have minimums like $1,000-$3,000. For long-term investors, the practical difference is minor; both can hold the same underlying index.
What is the expense ratio of an index fund?
An expense ratio is the annual fee a fund charges, expressed as a percentage of assets. Top broad-market index funds like VTI or SCHB charge 0.03-0.04%, meaning $3-$4 per year on a $10,000 investment. Anything above 0.20% for a basic index fund is typically considered expensive in 2026.
Should I invest in S&P 500 or total market index funds?
Both are reasonable; the difference is small. S&P 500 funds hold the 500 largest U.S. companies; total market funds add another ~3,000 mid- and small-cap stocks. The S&P 500 dominates total market performance because of its market-cap weighting, so the two tend to perform within a fraction of a percent of each other annually.
Quick check on this lesson
Answer each question and we’ll show you why the right answer is right, and why the others aren’t.
- 1.
What is an index fund?
- 2.
Why do most professional fund managers FAIL to beat their benchmark index over long periods?
- 3.
What CAN'T an index fund do?
0 of 3 answered