Index fund

A mutual fund or ETF that aims to match the performance of a market index by holding the same investments rather than picking winners.

What it means

An index is a list of securities that represents a market, such as the largest U.S. companies or the whole bond market. An index fund simply owns what is in the index, in about the same proportions, so its results rise and fall with that market minus a small fee. Because no one is paid to research and select investments, index funds tend to have low expense ratios.

An index fund cannot beat its index, but research has long found that many actively managed funds trail their benchmarks after fees over long periods. Its risks are the risks of the market it tracks, with no attempt to avoid downturns. Taxes follow the fund’s structure: index mutual funds and ETFs pass along dividends and occasional capital gains, and stock index funds tend to have low turnover and therefore fewer taxable distributions.

Example

For example, on a $10,000 balance, an index fund charging 0.05% costs about $5 a year, while a fund charging 1.00% costs about $100 a year.

How it’s used

A low-cost core holding for retirement accounts
Hands-off investing that does not require choosing stocks
Building a portfolio from a few broad funds covering stocks and bonds

Strengths and weaknesses

Strengths

Typically very low costs
Broad diversification across a whole market
Simple, transparent and predictable relative to its index

Weaknesses

Will fully share in market declines
Cannot outperform its index
Some indexes are concentrated in a few large companies or sectors

Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.