Index fund

What It Means

An index fund is a type of mutual fundMutual fundAn SEC-registered fund that pools money from many investors to buy stocks, bonds or other securities, with shares you can sell back to the fund each business day. See more or exchange-traded fundETFAn exchange-traded fund: a pooled investment fund whose shares trade on stock exchanges throughout the day at market prices. See more (ETF) that tries to match the returns of a market index. The S&P 500, the Russell 2000 and the Wilshire 5000 Total Market Index are examples of indexes these funds follow. Because the managers follow the index instead of choosing which securities to buy, the SEC notes an index fund may skip the research staff an actively managed fund pays for, which can mean lower costs for shareholders.

How People Say It

• "I just buy the index and leave it alone."
• "It's an S&P 500 index fund, so it moves with the market."
• "Check the expense ratio before you pick one."

The Breakdown

Formula used in the calculator

Value at the end = amount × (1 + (return minus yearly cost) ÷ 100) raised to the number of years. It's a simplified model that subtracts the cost from the return each year.

Worked example. Two funds each start with $1010,000 stepsA popular daily step goal that began as the name of a 1960s Japanese pedometer; later studies find health benefits begin well below it. See more,000 and earn the same 6% a year before costs for 20 years. The only difference is what each charges. These are example figures, not the costs of any real fund.

Fund A ends about $4,939 ahead, and all of that gap comes from cost.

What the result means. Investor.gov points out that funds take their fees and expenses out of the fund's assetsAssetsThings you own that are worth money, such as cash, investments, a home or a car. Your assets minus your debts is your net worth. See more, so you pay them indirectly, and that small differences in fees can turn into large differences in returns over time. The SEC's index fund bulletin says following an index may let a fund save on costs, yet fees still vary from fund to fund, so check each one's actual figures.

Where It Comes From

John C. Bogle launched First Index Investment Trust on August 31, 1976, built to track the S&P 500. It was the first index mutual fund open to individual investors, bringing a strategy that had been available mainly to institutions. The fund raised a little over $11 million at launch, far below what he had hoped, and it's known today as the Vanguard 500 Index Fund.

Good to Know

An index fund still rises and falls with its index, and Investor.gov warns that you can lose some or all of the money you put into a fund. Mutual funds aren't guaranteed or insured by the FDIC or any other government agency. Some funds follow non-traditional indexes, including smartSave More TomorrowA savings plan by Richard Thaler and Shlomo Benartzi in which you agree now to raise your retirement contribution each time you get a pay raise. See more beta and quant funds, and the SEC has a separate Investor Bulletin on their features and potential risks. Read a fund's prospectus to see which index it tracks and what it charges.

Related Terms and Categories

• ETF

  An exchange-traded fund: a pooled investment fund whose shares trade on stock exchanges throughout the day at market prices.

• Mutual fund

  An SEC-registered fund that pools money from many investors to buy stocks, bonds or other securities, with shares you can sell back to the fund each business day.

• Expense ratio

  The yearly share of a fund's assets used to pay its running costs, so a 0.40% expense ratio costs $40 a year for every $10,000 invested.

• Target-date fund

  A mutual fund or ETF that shifts its mix of investments toward more conservative ones as the year in its name, usually a retirement year, gets closer.

• Dollar-cost averaging

  Investing the same dollar amount at regular intervals no matter what prices do, so each payment buys more shares when prices are low and fewer when high.

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