Index Funds Explained for Beginners
Index funds are one of the simplest, cheapest ways to invest for the long term. Here's what they are, why low fees matter, the main types, how mutual funds and ETFs differ, the risks, and how to get started.
By Pond.com editors Updated 3 min read
Quick answer
- An index fund holds all or most of the investments in a market index, like the S&P 500, instead of trying to pick winners.
- That makes them diversified and usually very low cost.
- Fees are shown as an expense ratio; many broad index funds charge well under 0.1% a year.
- You can buy them as mutual funds or exchange-traded funds (ETFs).
- They still go up and down with the market, so they suit money you won't need for years.
If investing sounds complicated, index funds are a good place to start. Instead of choosing individual stocks, you buy a small slice of a whole market in one purchase, at a very low cost. They're widely used in 401(k)s, IRAs and regular brokerage accounts.
This article is general information, not financial advice.
What is an index fund?
An index is a list of investments that represents part of the market. The S&P 500, for example, tracks about 500 large US companies.
An index fund simply buys the investments in that index, in the same proportions. It doesn't try to beat the market; it aims to match it.
Think of it like buying a basket of fruit instead of betting on one apple.
Why people like them
- Diversification: one fund can hold hundreds or thousands of companies.
- Low cost: because no one is picking stocks, fees are low.
- Simplicity: there's little to research or monitor.
- Track record: over long periods, most actively managed funds have trailed their benchmark index after fees.
Why fees matter
A fund's yearly cost is its expense ratio. It sounds small, but over decades it adds up. On $100,000, a 1% fee costs $1,000 a year, while a 0.05% fee costs $50. Many broad index funds charge well under 0.1%.
Common types
| Fund | What it holds |
|---|---|
| S&P 500 | About 500 large US companies |
| Total US stock market | Large, mid and small US companies |
| International stock | Companies outside the US |
| Total bond market | A broad mix of US bonds |
| Target-date fund | A ready-made mix of index funds that gets more conservative as your retirement year approaches |
Mutual funds vs ETFs
Both can track an index.
- Index mutual funds are bought at the day's closing price, sometimes with minimum investments; they're common in 401(k) plans.
- Index ETFs trade like stocks during the day, often for the price of one share or less with fractional shares.
For long-term investors, either works. Focus on the index and the fee.
The risks
Index funds move with the market. In a downturn, they fall too, sometimes sharply. They're best for money you won't need for at least five years, and they work best when you keep investing through the ups and downs.
How to start
- Use tax-advantaged accounts first: a 401(k) with a match, then an IRA. See retirement accounts explained.
- Pick a broad, low-cost fund or a target-date fund.
- Invest automatically every payday.
- Leave it alone and avoid reacting to headlines.
Common questions
They're diversified, which reduces the risk of any single company, but they still rise and fall with the market and can lose value, sometimes a lot, in downturns. They're best for long-term goals where you have time to ride out drops.
Often very little. Many ETFs can be bought for the price of one share, and many brokers allow fractional shares for a few dollars. Some index mutual funds have minimum investments, while others have none.
It covers about 500 large US companies, which is broad, but it leaves out small companies, international stocks and bonds. Many investors add a total market, international or bond fund, or use a target-date fund that mixes them for you.