An index fund is the “buy the whole market” option. Instead of paying someone to pick winners, it simply copies a list of companies and holds all of them.
What an index is
An index is a list of stocks used to measure part of the market. The S&P 500 tracks 500 large US companies. The Nasdaq-100 tracks 100 large companies listed on the Nasdaq, with a lot of tech. In Canada, the S&P/TSX Composite covers a wide slice of Canadian stocks.
How the fund works
An index fund buys the stocks in an index in roughly the same proportions. When the index goes up 8%, the fund goes up about 8%, minus a small fee. There is no manager making bets, which is why the fees are low.
Why people like them
- Low cost. Fees are often a fraction of what an actively managed fund charges.
- Wide spread. One purchase gives you hundreds of companies.
- Simple. There is little to research and little to maintain.
What they do not do
An index fund will not protect you from a falling market. When the index drops 20%, so does your fund. It also will not beat the market, by design. Most people use them for the long haul and ride out the dips.
Index fund or ETF?
Many index funds are sold as ETFs, so the two terms overlap. See our guide on ETFs vs individual stocks and our comparison of index funds, ETFs and mutual funds.
Related reading
This is general education, not financial advice.
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