What Is an Index Fund and Should I Buy One?

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An index fund is a type of mutual fund that attempts to replicate the success of an index on the stock market. Index funds can be a great addition to retirement portfolios to mitigate some risk from individual stocks that may be more vulnerable to swings in the market. They allow investors to put their money in the entire stock market rather than in just a few single stocks.

Investors might consider index funds if they want to match, but not outperform, the larger market. Like any investment, index funds have advantages and disadvantages and may not be right for every investor.

Read on to see if investing in index funds is a good idea for you.

What Is an Index Fund and How Does It Work?

An index fund is a type of mutual fund. It allows a group of people to pool together their money to purchase a group of stocks. With an index fund, the stocks are selected to mirror a specific sector of the larger market.

Index funds are ideal for:

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What Is In an Index Fund?

An index is a group of stocks that together represent all or part of the greater stock market. The S&P 500 consists of 500 of the largest U.S. companies traded on the exchanges. The Russell 2000 is another popular index, consisting of 2,000 smaller-cap companies.

Index funds work by matching–or tracking–the performance of a stock market index, such as the S&P 500 or the Dow Jones Industrial Average. The stocks are specifically chosen to reflect the companies in the index the fund tracks.

A Deeper Explanation on Index Funds

Vanguard’s Total Stock Market Index Fund Admiral Shares contains stocks from 10 different market sectors based on a sampling of the index. Taken as a whole, the fund’s primary attributes are consistent with those of the index.

Index funds are not limited to stocks, though. Some index funds, like Fidelity’s U.S. Bond Index Fund (FXNAX), track the bond market. Like Vanguard’s Real Estate Index Fund (VGSIX), others are based on real estate securities.

Good To Know

When the market — or the sector of the market mimicked in the fund — performs well, so does the fund. It should not outperform or underperform its index. This is less risky than purchasing individual stocks.

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What an Index Fund Does Not Do

It’s helpful to understand what an index fund does not do:

Index Fund Examples

There are various types of index funds, ranging from broad market funds that map to the entire stock market to specific sector funds that may map to a small segment of a particular industry.

These funds are some of the largest index funds available:

Pros and Cons of Index Funds

It helps to understand the benefits and drawbacks before investing in index funds. Here are some index funds pros and cons.


Index funds have some advantages over other types of investments:

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As with all investments, there’s risk associated with index funds.

What Is the Difference Between an Index Fund and an ETF?

An exchange-traded fund combines features of index funds with features of intraday trading. ETFs are not mutual funds, but index funds and ETFs are similar in many ways.

They also have distinctive differences that make each product a better choice for certain investors. Here are key differences between an index fund and an ETF:

Index Fund vs. ETF

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Who Are Index Funds Best For?

Index funds are a relatively inexpensive and moderate-risk way to invest. They bring returns equal to, but not greater than, the sector or market they track. Index funds can be a good investment for certain investors.

Index funds are best if you:

  • Are a beginning investor still learning about the stock market
  • Want to invest in the stock market but don’t want to buy individual stocks
  • Need to diversify your portfolio
  • Prefer an investment product with lower risk than individual stocks
  • Don’t feel the need to beat the market or sector your index fund tracks

As with all investments, index funds do come with a degree of risk. You can lose money in an index fund. Do your research and speak to a financial advisor before making investment decisions.

Is Now a Good Time To Buy Index Funds?

For 2021, although some experts may disagree on when is the best time, a good rule of thumb for the vast majority of stock investments: it’s nearly impossible to perfectly time the market. Be patient and give your investment time to grow while it’s invested.

This article has been updated with additional reporting since its original publication.