An index fund tracks a market index, like the S&P 500, by holding all (or most) of the stocks in that index. Instead of trying to pick winners, it mirrors the market. That one design decision, passive tracking instead of active stock selection, turns out to be one of the most powerful advantages any ordinary investor can have. The evidence is overwhelming, the costs are minimal, and getting started takes about 15 minutes.
How an index fund actually works
The S&P 500 tracks the 500 largest US companies by market capitalization: Apple, Microsoft, Amazon, and so on down the list. An S&P 500 index fund holds shares in all 500 of those companies, weighted by size. When Apple’s share price rises, Apple’s weight in the index rises, and your fund automatically holds slightly more Apple. When a company falls out of the top 500, the index drops it and your fund follows.
There is no fund manager deciding which stocks to buy. There is no research team, no trading desk making calls at 6am. The fund runs mechanically according to the index rules, which is precisely why it costs so little to operate, and why those savings flow directly to you.
Exchange-traded funds (ETFs) are index funds you buy and sell through a brokerage like a stock, at real-time prices throughout the day. Traditional index mutual funds trade once per day at end-of-day prices. For long-term investors the practical difference is negligible; both give you the same underlying exposure.
The fee advantage: and why it compounds so dramatically
According to Morningstar’s 2024 Annual US Fund Fee Study, the asset-weighted average expense ratio across all US funds fell to 0.34% in 2024, down from 0.83% in 2005. Index funds sit well below that average. Many broad market index funds now charge between 0.03% and 0.07% per year. Fidelity runs several index funds at 0.00%, zero fee.
Active funds, by contrast, typically charge 0.60% to 1.50% or more. That gap feels small in year one. Over 30 years, it rewrites the outcome.
| Investment type | Annual fee | $10,000 over 30 years at 9% gross return |
|---|---|---|
| Low-cost index fund | 0.04% | ~$128,000 |
| Average active fund | 0.75% | ~$104,000 |
| High-cost active fund | 1.50% | ~$84,000 |
The difference between the index fund and the high-cost active fund in this example is over $44,000, on a $10,000 starting investment, without any additional contributions. Fees are the single most controllable variable in long-term investing.
What the data says about active funds vs. index funds
Every year, S&P Dow Jones publishes the SPIVA report (S&P Indices Versus Active), which tracks how actively managed funds perform against their benchmark index. The year-end 2024 results:
- Over 15 years, more than 90% of US large-cap actively managed funds underperformed the S&P 500
- 92.5% of global funds underperformed the S&P World Index over the same 15-year period
- Underperformance rates consistently rise as the time horizon lengthens, the longer the period, the fewer active funds survive and beat their index
This is not a recent phenomenon. The results have been consistent for two decades. The primary cause is fees: every dollar paid in management fees is a dollar of return that never compounds.
The market has noticed. As of February 2026, combined assets in indexed mutual funds and ETFs reached $20 trillion, surpassing actively managed funds for the first time in history (Investment Company Institute).
The S&P 500’s long-term track record
Since 1957, the S&P 500 has delivered an average annual return of approximately 10.3% (before inflation). Over the past 30 years through 2024, the average annualized return was roughly 10.4%. Inflation-adjusted, that’s closer to 6–7% in real purchasing power, still enough to meaningfully grow wealth over decades.
These averages include crashes: 2000–2002, 2008–2009, 2020, 2022. Holding through downturns, rather than selling, is what allows investors to capture the long-run average. Morningstar’s 2024 “Mind the Gap” study found that the average dollar invested in US funds earned 7.0% per year over the decade ending December 2024, about 1.2 percentage points less than the funds’ own reported returns, because investors tended to buy after rallies and sell after drops. Staying invested, not reacting to headlines, is where most of the return gap is recovered.
Comparing common index funds
These are among the most widely held index funds. Expense ratios shown are current as of 2025:
| Fund | Index tracked | Type | Expense ratio |
|---|---|---|---|
| Vanguard VTI | Total US market (~3,600 stocks) | ETF | 0.03% |
| Vanguard VTSAX | Total US market | Mutual fund | 0.04% |
| Fidelity FZROX | Total US market | Mutual fund | 0.00% |
| iShares IVV | S&P 500 | ETF | 0.03% |
| Schwab SCHB | Broad US market | ETF | 0.03% |
| Vanguard VXUS | Total international (ex-US) | ETF | 0.07% |
Most financial advisors who recommend passive investing suggest pairing a total US market fund with a total international fund. A simple split, 70% US, 30% international, gives you exposure to thousands of companies across dozens of countries.
Should you invest in one?
Yes, if all of these apply:
- You have an emergency fund covering 3–6 months of expenses
- You’re investing for at least 5 years, ideally 10+
- You want to build wealth without spending hours analyzing stocks
- You’re using a 401k, IRA, or taxable brokerage account
Not yet, if:
- You carry high-interest debt (credit cards at 20%+ APR, pay those first)
- You have no emergency savings (a market drop while cash-strapped forces selling at the worst time)
- You need the money within 3–5 years (short time horizons cannot absorb a 30–40% drawdown)
What to watch out for
Confusing “low fee” with “zero fee.” A 0.00% expense ratio sounds perfect, but some zero-fee funds make money through securities lending revenue that does not benefit you directly. This is not a reason to avoid them, the funds are still legitimate and cost-effective, just understand the mechanics.
Chasing last year’s best-performing index. An index fund that tracks a narrow sector (technology, AI, clean energy) concentrates your risk significantly. Broad market funds avoid this problem by design. A sector ETF that returned 40% one year can lose 50% the next.
Investing money you’ll need soon. Index funds tied to the stock market will lose value in crashes, sometimes 30–40%. If you have a car purchase or home down payment in 18 months, that money belongs in a high-yield savings account, not equities.
Neglecting tax location. If you hold index funds in both a taxable brokerage and a retirement account (IRA/401k), put more tax-inefficient investments in the retirement account and broad index funds in both. For most people starting out, this matters less than simply investing at all.
Getting started
- Capture any employer 401k match first. If your employer matches 4% of salary and you’re not contributing 4%, that’s free compensation going unclaimed.
- Open a Roth IRA (if you’re under the income limit, roughly $161,000 single or $240,000 married for 2026). Max the contribution ($7,000 in 2026, or $8,000 if you’re 50+).
- Choose a single total market index fund, VTI, FZROX, or your 401k’s equivalent option. One fund is sufficient to start.
- Automate a monthly contribution. Removing the decision removes the temptation to time the market.
- Add international exposure later with a total international fund once you’ve built the habit.
The honest summary: index funds are not exciting. They will not beat the market, they will match it, after costs, which outperforms most active managers over any 15-year period. That is the point. Boring, consistent, low-cost compounding is how most people actually build lasting wealth.