Index funds are mutual funds or exchange-traded funds (ETFs) that have one simple goal: To mirror the market or a portion of it. For example, an S&P 500 index fund tracks the collective performance of the hundreds of companies in the S&P 500. If the S&P 500 is up 5 percent in a year, the fund should be close to that, too.
Index funds are typically passively managed, meaning there is no active manager to pay. Rather than trying to bet on individual stocks to beat the market, an index fund simply aims to “be the market” with an autopilot approach that holds the same securities in the same proportion as the index. Here’s the kicker: Most active fund managers actually fail to beat the market and instead underperform their target index. Why pay more for less when you can take advantage of the track record of a broad-based market index?
Popular types of index funds
U.S. stock indexes
The S&P 500 index is one of the most used benchmarks for stocks focused on large U.S.-based companies. While the companies in the S&P account for approximately 80 percent of the total value of the U.S. stock market, some investors opt for extended market index funds that help track that remaining 20 percent. The Russell 1000 index tracks the 1,000 biggest U.S. stocks, and the FT Wilshire 5000 index effectively represents every publicly traded stock in the country.
The Nasdaq 100 is another popular index because it contains major tech companies such as Apple and Amazon, and has delivered high returns for years.
International stock indexes
Investors can seek to capitalize on growth opportunities throughout the rest of the world, too, via a plethora of index funds that track equities in developed and emerging markets across the globe. There are also total international index funds that cover everything outside the U.S.
Bond indexes
In addition to investing in broad-based stock index funds, you can choose from a range of bond index funds: for example, short-term bonds with maturity dates in the near future, long-term bonds with maturities longer than 10 years, emerging market government bonds and more.
Dividend indexes
Some fund managers create and track their own proprietary indexes, including dividend stock indexes. Dividend indexes include only stocks that pay a dividend, and the ETFs are a popular way for investors to get access to a diversified portfolio of dividend-paying companies.
How to invest in index funds: Two key factors
Index funds are available to anyone who wants to invest money. ETFs typically require a purchase of at least one share, though brokers offering fractional shares can help you get around that. But index mutual funds may ask for an initial deposit of $1,000 or more. Many of these index funds track the same index, so it’s important to pay attention to two key factors when comparing them.
