What is Index fund?

An index fund is a fund that buys the shares in a market index and holds them in the same proportions. An index is a published list of companies used to measure a market. The S&P 500, for example, follows 500 large US companies. Rather than paying people to pick winners, the fund copies the list, so its return closely matches the index, minus a small fee. Index funds exist as traditional mutual funds and as exchange-traded funds (ETFs), which trade on a stock exchange like a single share. An S&P 500 fund such as SPY is one example.

Most large indices weight each company by its market capitalisation, the total value of all its shares, so the biggest companies make up the largest slices of the fund. Because the fund only trades when the index changes, its turnover stays low. Turnover is the share of holdings bought and sold each year, and keeping it low keeps costs down. The annual fee, called the expense ratio, is charged as a percentage of the money invested. For the large S&P 500 funds VOO, SPY and IVV it ranges from 0.03% to 0.09%.

Fees look small, but they compound. Say you invest $10,000 and, purely as an illustration, the index returns 7% a year. A fund charging 0.05% leaves about 6.95% a year, while a fund charging 1% leaves about 6%. After one year the difference is roughly $95, because $10,695 compares with $10,600. After 30 years, $10,000 growing at 6.95% becomes about $75,000, while at 6% it becomes about $57,400. The gap of roughly $17,600 comes entirely from the fee.

An index fund matches the market; it does not protect against it. When the index falls, the fund falls with it. The S&P 500 lost 54.6% with dividends from peak to low in 2007–2009, and the Nasdaq-100 fell 83% from 2000 to 2002. A common misunderstanding is that one index fund means full diversification. An S&P 500 fund spreads money across hundreds of companies but only one asset class, US shares, and a handful of very large companies can dominate it.

For a private investor building a long-term portfolio, index funds offer broad exposure at very low cost and with little effort. Every dollar paid in fees is a dollar that stops compounding, so cost differences add up over decades. The S&P 500 returned 10.2% a year over the 30 years to June 2026 with dividends reinvested, and index funds are a direct way to capture market returns like these. The main decisions then shift from choosing shares to choosing the mix of asset classes and holding it through declines.

By Dr. Harry Hamann

What is the difference between an index fund and an ETF?
An index fund describes the strategy of tracking an index. An ETF describes the structure, a fund that trades on a stock exchange during the day. Many ETFs are index funds, but some index funds are mutual funds priced once a day.

Are index funds safe?
They remove the risk of picking the wrong company, but not market risk. An S&P 500 index fund fell as much as the index itself, which lost 54.6% with dividends from peak to low in 2007–2009.

How much do index funds cost?
Costs vary by provider and market. The large S&P 500 funds VOO, SPY and IVV charge annual fees of 0.03% to 0.09%, which is $3 to $9 a year for every $10,000 invested.