Index fund
Also known as: index mutual fund, passively managed fund
An index fund is a mutual fund or ETF designed to match the performance of a market index, such as the S&P 500, by holding the same securities in the same proportions. Because it is passively managed, it typically charges lower fees than actively managed funds.
An index fund is an investment company product built to track a benchmark index rather than beat it. Instead of employing managers to pick stocks, the fund simply buys the securities in its target index — the S&P 500, a total bond market index, an international index — and holds them in the same weights as the index itself.
Because the portfolio only changes when the underlying index changes, index funds trade infrequently. An S&P 500 index fund, for example, holds all 500 component stocks weighted by market capitalization, and its return mirrors the index's return minus a small expense ratio. Low turnover also means fewer taxable capital gains distributions for shareholders.
Index funds matter because costs compound. A passively managed fund charging a fraction of a percent per year leaves more of the market's return in the investor's pocket than an active fund charging several times as much — and over long periods, most active managers fail to outperform their benchmark after fees. That combination of broad diversification, low cost, and tax efficiency makes index funds a common recommendation for long-term investors.
Securities licensing exams — including the SIE, Series 6, and Series 7 — test index funds within the investment companies material. Expect questions contrasting passive and active management, identifying why expense ratios are lower for index funds, and judging suitability: an index fund is often the answer for a cost-conscious investor seeking diversified, long-term market exposure.
Key takeaways
- An index fund passively tracks a market index instead of trying to outperform it.
- Its return approximates the index's return minus a small expense ratio.
- Low turnover keeps management fees and taxable distributions low compared to active funds.
- The SIE, Series 6, and Series 7 exams test index funds under investment companies and suitability.