An index fund is a type of investment fund that tracks a market index — a pre-defined list of stocks or bonds used to measure market performance. The S&P 500 is the most well-known US index: it tracks the 500 largest publicly traded US companies. An S&P 500 index fund tries to mirror that index as closely as possible.
A market index is a collection of securities that represents a segment of the market. It's used as a benchmark to measure how well a particular market, sector, or category is performing.
Actively managed funds have a human portfolio manager (or team) who researches stocks and makes decisions about what to buy and sell. They try to outperform the market. Index funds are passive — they automatically hold whatever is in the index, with no attempt to pick winners. Because passive funds require less human involvement, they tend to charge significantly lower fees.
A 1% difference in annual fees might seem small, but over 30 years on a growing balance, it can result in tens or hundreds of thousands of dollars in additional cost. This is one of the most cited reasons for using index funds — you keep more of your returns.
Both track an index. The difference is structure. Index mutual funds are typically bought directly from the fund company and priced once daily. Index ETFs are traded on stock exchanges throughout the day like stocks. For most beginners, index ETFs are more accessible because they have no investment minimums beyond the price of one share.
No. Index funds reflect the market they track. When the market falls, so do index funds. Over long historical time horizons, broad market indexes have generally recovered from downturns, but past performance is not a guarantee of future results.
An S&P 500 fund tracks only the 500 largest US companies. A total market index fund includes small and mid-sized companies as well. The total market fund is broader and includes more companies.
Yes. Index funds and index ETFs are available inside most 401(k)s, IRAs, and other retirement accounts. Holding them in tax-advantaged accounts can help reduce the tax on dividends and capital gains.
Educational content only. MyMoneyStep does not provide investment advice. All figures are illustrative.