What is an index fund? | Vanguard (2024)

FAQs

What is an index fund? | Vanguard? ›

An index mutual fund or ETF (exchange-traded fund) tracks the performance of a specific market benchmark—or "index," like the popular S&P 500 Index—as closely as possible. That's why you may hear people refer to indexing as a "passive" investment strategy.

An index fund is a portfolio of stocks or bonds designed to mimic the composition and performance of a financial market index. Mutual and exchange-traded funds (ETFs) have many different varieties of low-cost index funds focused on some part of the market—or the whole of it.

Index funds are a popular choice for beginners because they offer an easy way to diversify your investments (like not putting all your eggs in one basket) and they usually have lower fees than actively managed funds.

An index fund tends to include both high- and low-performing stocks and bonds in the index it's tracking. Any returns you earn would be an average of them all. Still, the historical average return of the general stock market has been quite high.

While an S&P 500 index fund is the most popular index fund, they also exist for different industries, countries and even investment styles.

Capital gains taxes on that sale are yours and yours alone to pay. To get cash out of an index fund, you technically must redeem it from the fund manager, who will then have to sell securities to generate the cash to pay to you.

Ideally, you should stay invested in equity index funds for the long run, i.e., at least 7 years. That is because investing in any equity instrument for the short-term is fraught with risks. And as we saw, the chances of getting positive returns improve when you give time to your investments.

While indexes may be low cost and diversified, they prevent seizing opportunities elsewhere. Moreover, indexes do not provide protection from market corrections and crashes when an investor has a lot of exposure to stock index funds.

Index funds are generally more cost-effective than actively managed funds, but can still be pricey depending on the fund. For example, the Vanguard 500 Index Fund has a $3,000 minimum investment. The Schwab S&P 500 Index fund and Fidelity Zero Large Cap Index have no minimum.

The 4% rule says people should withdraw 4% of their retirement funds in the first year after retiring and take that dollar amount, adjusted for inflation, every year after.

What is the most profitable index funds? ›

The SPDR S&P Dividend ETF (SDY -0.37%) is a top-performing index fund for income-oriented investors. The dividend-weighted fund's benchmark is the S&P High Yield Dividend Aristocrats® Index, which tracks 135 stocks with the highest dividend yields in the S&P Composite 1500 Index.

Like stocks, you invest in an index fund by purchasing individual shares. You then own a percentage of the overall portfolio equivalent to how many shares you bought and are entitled to the fund's returns on that pro-rata basis. For example, say that the ABC Fund releases 50% of its value in the form of 100 shares.

For most investors looking for a cost-effective, easy way to track market returns, index funds are absolutely worth considering.

S&P 500 10 Year Return (I:SP50010Y)

S&P 500 10 Year Return is at 181.9%, compared to 186.0% last month and 176.0% last year. This is higher than the long term average of 115.5%.

In summary, when comparing dividend vs index investing, a common question is “do index funds pay dividends?” The answer is that some index funds do pay dividends, depending on the holdings of the underlying index. Index funds offer advantages such as lower management expense ratios and broad market exposure.

Index funds take a lot of the burden off of investors by investing in hundreds—or even thousands—of different stocks and bonds. That means you don't have to worry about picking any one winning stock and instead can benefit from the overall growth of the market or industry your fund is tracking.

Index funds are generally more cost-effective than actively managed funds, but can still be pricey depending on the fund. For example, the Vanguard 500 Index Fund has a $3,000 minimum investment. The Schwab S&P 500 Index fund and Fidelity Zero Large Cap Index have no minimum.