Index Fund

An index fund is a mutual fund or ETF that aims to replicate the performance of a market index — such as the S&P 500, the total US bond market, or the entire global stock market — rather than trying to beat it. Instead of a manager picking individual securities, the fund simply holds the components of its target index in their appropriate weights and adjusts only when the index itself changes.

This passive approach has two powerful advantages. First, it is cheap: with no research staff or active trading to fund, index funds carry very low expense ratios, often a few hundredths of a percent. Second, it is reliable: rather than gambling on a manager's ability to produce alpha — which most fail to do after fees — an index fund guarantees you the market's return minus a tiny cost. Paradoxically, aiming only to match the market has historically beaten the majority of investors who try to beat it.

Index funds are the natural building blocks for the asset allocation strategies on this site. Because each fund cleanly represents one asset class — US large caps, long-term Treasuries, gold, and so on — investors can assemble any target allocation precisely and cheaply, then maintain it with periodic rebalancing. Nearly every ETF profiled here is an index fund of this kind.

The main practical decisions are which index to track (broad total-market indexes maximize diversification) and which wrapper to use — a traditional mutual fund or an ETF. That choice comes down to trading flexibility and tax treatment, the subject of ETF vs. mutual fund.