An index fund is a fund built to follow a market index, such as a list of large U.S. companies.
What it means
The fund usually buys the investments in the index or a sample that acts much like it. The goal is to follow the index, not outguess it.
Index funds often cost less than actively managed funds. They can be mutual funds or exchange-traded funds.
A simple example
An index lists a group of investments and gives each one a place in the list. If one company makes up 5% of the index, a fund following that index may put close to 5% of its money in that company. The fund changes as the index changes.
The manager is not choosing that company because it looks like the next winner. The job is to follow the list. That can keep costs and trading lower, but it does not make the fund safe. If the whole index falls—or if a few large companies dominate it—the index fund can fall too.
What people often miss
The word index does not mean safe. The fund can fall when the market it follows falls.
Two index funds may follow different lists and own very different things. Read the index name and the top holdings.
Three questions worth asking
- Which index does the fund follow?
- What does the index actually own?
- What is the expense ratio?
Checked against primary sources
This explanation was checked against the sources below. Rules and limits can change, so check the source before making a decision.
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