Investing & Markets

What is Index Fund?

An index fund is a fund designed to track a specific market index, like the S&P 500. It’s passively managed, which keeps costs low. Aggregate Bond Index. Index funds are passively managed, meaning the fund manager simply buys the securities in the target index, rather than actively selecting stocks.

Because they require minimal management, index funds offer significantly lower expense ratios than actively managed funds. Studies monitored by the SEC show that passive index funds historically outperform the majority of active managers over long horizons.

Index funds provide broad diversification, lowering single-stock risk. They are a core component of modern portfolio theory, allowing retail investors to participate in market growth at minimal cost. They are highly tax-efficient due to low portfolio turnover.

Quick Facts

Management StylePassive tracking of target index, low turnover

Cost AdvantageSignificantly lower expense ratios than active funds

Benchmark CoverageS&P 500, Dow Jones, total bond market indexes

Tax ProfileHigh tax efficiency due to minimal buying and selling

PRACTICAL EXAMPLE

An investor chooses an S&P 500 index fund with an expense ratio of 0.03%. The fund holds shares in all 500 S&P companies. If the S&P 500 index returns 10% in a year, the investor's portfolio returns approximately 9.97%, minus the tiny management fee.

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RELATED TERMS

Learn More Key Concepts

StockA financial security representing a fractional share of ownership in a corporation, conveying voting rights and claims on assets.

ETFAn investment fund trading on stock exchanges, holding assets like stocks or bonds, and tracking specific indexes.

Mutual FundA pooled investment vehicle managed by professionals that buys a diversified portfolio of securities, priced once daily.

PortfolioA collection of financial investments, such as stocks, bonds, cash equivalents, and alternative assets, held by an investor.

DiversificationA risk management technique that mixes a wide variety of investments within a portfolio to reduce volatility and single-stock risk.

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