Index funds continue to be an attractive investment option due to their simplicity, low costs, and ease of management. While index funds can be a smart investment for both savvy and novice investors alike, they're particularly well suited for beginners and investors who prefer a low-maintenance, low-effort approach to investing.
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What is an index fund?
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Definition of an index fund
An index fund is a type of investment that tracks the performance of a specific benchmark like the S&P 500 or the Dow Jones Industrial Average. Instead of picking individual stocks, an index fund tracks the performance of a specific market benchmark—or "index," like the popular S&P 500 Index—as closely as possible.
Rather than hand-selecting which stocks or bonds the fund will hold, the fund's manager buys all (or a representative sample) of the stocks or bonds in the index it tracks. By investing in an index fund, you essentially own a small piece of every investment within the index, which helps diversify risk and could lead to long-term growth. An index fund is designed to keep pace with the benchmark, as opposed to an actively managed strategy that seeks to outperform the benchmark.
Discover the wide range of Vanguard mutual funds and explore the benefits and options available to help you achieve your financial goals.
Example of an index fund
What is Vanguard 500 Index Fund Admiral™ Shares?
Vanguard 500 Index Fund Admiral Shares (VFIAX) is an example of an index fund that aims to track the performance of the S&P 500 Index. The S&P 500 is a market-capitalization-weighted index that includes 500 of the largest publicly traded companies in the U.S. By investing in VFIAX, you're essentially buying a small piece of each of these 500 companies, proportional to their weight in the index.
How it works
- Portfolio composition. VFIAX holds shares of all 500 companies listed in the S&P 500. The fund is structured to match the weightings of these companies in the index. For example, if Apple makes up 7% of the S&P 500, VFIAX will also allocate about 7% of its portfolio to Apple.
- Passive management. VFIAX is passively managed, meaning it does not try to outperform the S&P 500. Instead, it aims to replicate the index's performance as closely as possible. This approach keeps management fees low—typically much lower than those of actively managed funds.
- Performance. The performance of VFIAX closely follows the performance of the S&P 500, minus a small expense ratio. For instance, if the S&P 500 were to increase by 10% in a year, VFIAX would be expected to also increase by about 10%, minus the fund's expense ratio.
Historical performance and average index fund returns
Index fund investing has historically provided strong returns, particularly when tracking a well-diversified index like the S&P 500. Here are some key historical performance metrics for several high-profile indexes:
| Index | 1-year return | 5-year return | 10-year return | 20-year return |
|---|---|---|---|---|
| S&P 500 | 12.10% | 15.61% | 12.32% | 10.30% |
| Dow Jones Industrial Average (DJIA) | 9.48% | 13.05% | 11.04% | 9.77% |
| Nasdaq 100 | 13.10% | 17.75% | 17.20% | 15.06% |
| Russell 2000 | 0.87% | 9.88% | 6.32% | 7.74% |
Historical performance of major indexes, including the S&P 500, over a 20-year return period (Morningstar, Inc., as of April 30, 2025).
Past performance is not a guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
Types of index funds
Index funds come in various types, each designed to track a specific market segment or asset class. Understanding the different types of index funds can help you align your investments with your financial goals.
Here's a breakdown of the main types of index funds and how they can fit into different investing strategies:
- Description: Track broad stock market indexes like the S&P 500.
- Financial goals: Long-term growth, diversification, retirement savings.
- Description: Track bond market indexes, including government, corporate, and municipal bonds.
- Financial goals: Regular income, stability, portfolio diversification.
- Description: Focus on specific sectors like technology, health care, or energy.
- Financial goals: Sector exposure, thematic investing, higher growth potential (with higher risk).
- Description: Track international stock or bond indexes, covering developed or emerging markets.
- Financial goals: Global diversification, exposure to international growth, hedging against currency risks.
- Description: Focus on stocks of smaller or mid-sized companies.
- Financial goals: Higher growth potential (with higher risk), portfolio diversification.
- Description: Track indexes of companies with a history of paying consistent dividends.
- Financial goals: Regular income, stability, balanced growth and income.
- Description: Focus on companies with strong ESG practices.
- Financial goals: Ethical investing, risk management, potential long-term outperformance.
By choosing the right type of index fund, you can tailor your investment strategy to meet your specific financial goals and risk tolerance.
Benefits of index funds
Index funds have gained significant popularity among investors due to their numerous benefits.
Their straightforward nature makes them easy to understand and manage, making them attractive to both novice and experienced investors alike. Some benefits include:
- Low costs. Typically offer lower fees and expenses compared with actively managed funds.
- Transparency. Provide a clear and straightforward investment strategy that's easy to understand.
- Accessibility. Feature low minimum investments and are easy to buy through most brokerage accounts; attractive to investors looking for a simple way to invest.
- Tax efficiency. Can result in lower tax bills because the index funds don't frequently buy and sell investments, which can mean fewer capital gains are realized.
- Lower risk through broader diversification. Help reduce the impact of any single security's poor performance by spreading investments across a wide range of assets, contributing to lower overall risk and supporting long-term investment success.
Index mutual funds versus index ETFs
When comparing passive investment vehicles, it's important to understand the differences between index mutual funds and index ETFs (exchange-traded funds).
To be clear, "index" is a descriptor that defines the benchmark, while index mutual funds and index ETFs are the actual investment products that seek to match the performance of that benchmark. Both are designed to track a specific market index, but they have distinct differences that can affect your investment strategy. They include:
- Structure and trading. Mutual funds are bought and sold at the end of the trading day at the net asset value (NAV) price, while ETFs trade throughout the day on exchanges, allowing for more flexibility and the ability to buy and sell at current market prices.
- Costs. Index ETFs generally have lower expense ratios compared with mutual funds, making them a more cost-effective option for many investors.
- Minimum investment. Mutual funds often have higher minimum investment requirements, whereas ETFs can be purchased in smaller quantities, making them more accessible to a wider range of investors.
- Tax efficiency. ETFs are often more tax-efficient than mutual funds due to their unique creation and redemption process, which can minimize capital gains distributions.
Understanding these differences can help you choose the investment vehicle that best aligns with your financial goals and investment strategy.
Dive deeper into the world of investments and learn how to select the right options for your financial journey.
How to invest in index funds
Index fund investing is a straightforward way to gain exposure to a broad market or specific sector.
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Start by choosing a fund that aligns with your investment goals and has a low expense ratio.
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Next, open a brokerage account with a broker that offers low fees, user-friendly platforms, and a
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Fund your account by transferring money from your bank and placing your order to buy shares of the index fund.
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Monitor its performance regularly and consider setting up automatic investments to build your portfolio over time.
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For tax benefits, consider investing through a retirement account like an IRA, or a 401(k) if your employer offers one.
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Sometimes you have the option of buying shares directly from the fund company through a direct purchase plan, which may require a minimum investment. Vanguard ETFs® are available for as little as $1 and allow investors to take advantage of low-cost options.
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Finally, periodically review and rebalance your portfolio to maintain your desired asset allocation.
By following these steps, you can start investing in index funds and benefit from their low costs and broad market exposure.
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Vanguard started the indexing revolution
Vanguard pioneered the index fund with the launch of the first retail index fund in 1976, revolutionizing the way investors build their portfolios.
Today, we offer a wide range of low-cost index funds that provide broad market exposure and are designed to align with various investment goals. Whether you're looking to diversify your portfolio, achieve long-term growth, or benefit from tax-efficient investing, Vanguard has the options to help you reach your financial milestones.
Choose from more than 200 Vanguard index mutual funds and ETFs that track indexes across nearly all U.S. and international stock and bond markets.
For more information about Vanguard mutual funds and ETFs, visit Vanguard mutual fund prospectuses or Vanguard ETF prospectuses to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information are contained in the prospectus; read and consider it carefully before investing.
You must buy and sell Vanguard ETF Shares through Vanguard Brokerage Services (we offer them commission-free online) or through another broker (who may charge commissions). See the Vanguard Brokerage Services Commission and Fee Schedules for limits. Vanguard ETF Shares are not redeemable directly with the issuing Fund other than in very large aggregations worth millions of dollars. ETFs are subject to market volatility. When buying or selling an ETF, you will pay or receive the current market price, which may be more or less than net asset value.
All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Fluctuations in the financial markets and other factors may cause declines in the value of your account.
Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.
Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.
Funds that concentrate on a relatively narrow market sector face the risk of higher share-price volatility. Prices of mid- and small-cap stocks often fluctuate more than those of large-company stocks.
ESG funds are subject to ESG investment risk, which is the chance that the stocks or bonds screened by the index provider or advisor, as applicable, for ESG criteria generally will underperform the market as a whole or, in the aggregate, will trail returns of other funds screened for ESG criteria. The index provider or advisor's assessment of a company, based on the company's level of involvement in a particular industry or their own ESG criteria, may differ from that of other funds or an investor's assessment of such company. As a result, the companies deemed eligible by the index provider or advisor may not reflect the beliefs and values of any particular investor and may not exhibit positive or favorable ESG characteristics. The evaluation of companies for ESG screening or integration is dependent on the timely and accurate reporting of ESG data by the companies. Successful application of the screens will depend on the index provider or advisor's proper identification and analysis of ESG data. The advisor may not be successful in assessing and identifying companies that have or will have a positive impact or support a given position. In some circumstances, companies could ultimately have a negative or no impact or support of a given position.
This page is for general guidance only and does not take into consideration your personal circumstances or other factors that may be important in making investment decisions. We recommend that you consult a financial or tax advisor about your individual situation before investing.