What Is an Index Fund?

An index fund is a basket of investments designed to follow a market index. An index is a published list of companies or bonds, such as all the large U.S. companies in a particular group. The fund buys the same investments, in roughly the same proportions, so its performance tracks the index.

Because an index fund simply follows a list, it does not need a team of analysts trying to beat the market. That is why index funds usually charge lower fees than actively managed funds, which try to pick winners.

Lower fees matter. A fee is taken from your investment every year. Over decades, a small difference in fees can add up to a large difference in what you keep.

Index funds also spread your risk. Owning hundreds or thousands of companies means no single company’s failure can sink your investment. You still own the risk of the whole market, which can fall. Diversification reduces single-company risk, but it does not remove market risk.

Index funds are sold as mutual funds or exchange-traded funds (ETFs). Both can track an index. The main differences are in how they trade and in some tax details, which you can check with your brokerage.

When you look at an index fund, check its expense ratio, which is its yearly fee. Check what it holds. Choose a category, such as total stock market or total bond market, that fits your goals.

An index fund does not guarantee a profit. It is a low-cost way to own a broad part of the market.