If you want to grow your money without constantly checking the stock market, index funds could be your smartest bet. They’re low-cost, easy to understand, and built for long-term growth—even if you’re not an investing expert.
Index funds have become a go-to strategy for investors who want steady returns without paying high fees or trying to time the market. They’re often recommended by top financial minds, including Warren Buffett, who has said that most people would be better off investing in low-cost index funds than trying to beat the market.
In this guide, we’ll break down exactly how index funds work, how they compare to mutual funds and ETFs, and how you can start investing in them today.
Key Takeaways
- An index fund is a type of mutual fund or ETF that aims to match the performance of a specific market index, offering broad diversification at a low cost.
- Index funds are passively managed, unlike many mutual funds that are actively managed. ETFs trade like stocks throughout the day, while index funds trade at the end-of-day price. Index funds typically come with lower fees and better tax efficiency.
- The main benefits of index funds are diversification, low costs, and steady returns. Downsides include limited upside, market risk, and heavy exposure to large companies in some indexes.
What is an index fund?
An index fund is an investment that aims to match the performance of a specific market index—like the S&P 500 or Dow Jones Industrial Average. It does this by holding the same stocks or bonds included in that index.
You can invest in index funds through either mutual funds or ETFs. Both offer low fees, broad diversification, and a simple way to grow your money over time without picking individual stocks.
How Index Funds Work
Index funds follow a passive strategy. Instead of trying to beat the market, they mirror it by holding the same assets as the index they track.
This approach keeps costs low and reduces the need for frequent trading. Your returns move in step with the overall market, offering a balance of risk and long-term growth.
Index Funds vs. Mutual Funds vs. ETFs: What’s the difference?
Index funds, mutual funds, and ETFs might seem similar, but they work differently in key ways. The biggest differences come down to how they’re managed, how they’re traded, and how much they cost.
- Index funds are passively managed. They aim to match the performance of a market index by holding the same stocks or bonds. This hands-off approach keeps fees low and makes them a simple choice for long-term investing.
- Mutual funds are usually actively managed. Fund managers try to beat the market by picking stocks or timing trades. That can lead to higher returns—but also higher fees and more risk if those bets don’t pay off.
- ETFs are often passively managed like index funds, but they trade like stocks. You can buy and sell them throughout the day at market prices. This gives you more control and can lead to better tax efficiency compared to traditional mutual funds.
Index Funds vs. Actively Managed Funds
Active funds try to beat the market. Index funds try to match it. That simple difference leads to very different results over time.
- Actively managed funds rely on a manager’s ability to pick the right stocks or time the market. In theory, this could lead to higher returns. In practice, most active funds underperform their benchmarks, especially after fees. Research has consistently shown that only a small percentage of active managers outperform the market over long periods.
- Index funds, on the other hand, keep costs low by sticking to a set list of investments. There’s no guesswork, and no constant buying and selling. This passive strategy keeps fees down, which has a big impact on long-term returns.
For most investors—especially beginners—index funds offer a more reliable way to build wealth without the risks and costs of active management.
Popular Stock Indexes That Index Funds Track
Index funds follow specific stock market benchmarks. Each one reflects a different slice of the market and helps shape how a fund is built and how it performs over time.
Dow Jones Industrial Average
The Dow Jones Industrial Average tracks 30 of the largest companies in the U.S. These are well-known brands from sectors like technology, finance, and consumer goods. While the Dow is narrower than other indexes, it’s one of the oldest and most followed in the market.
S&P 500
The S&P 500 includes 500 of the largest U.S. companies across many industries. It’s widely used as a measure of overall market performance. Many index funds use the S&P 500 as their benchmark because of its broad coverage and strong long-term results.
Nasdaq Composite Index
The Nasdaq Composite includes more than 3,000 companies listed on the Nasdaq exchange. It’s heavily weighted toward tech firms, including both major players and smaller growth companies. This index is a common way to track the tech sector.
Russell 3000
The Russell 3000 covers the 3,000 largest publicly traded U.S. companies. It represents about 98% of the total market and includes both large-cap and small-cap stocks. This index is often split into the Russell 1000 for larger companies and the Russell 2000 for smaller ones.
Pros & Cons of Investing in Index Funds
Index funds offer a simple way to invest in the market, but they’re not the right fit for every strategy. Here’s a clear look at the benefits and drawbacks.
Pros
- Diversification – Index funds spread your money across hundreds or even thousands of stocks or bonds. This lowers the risk tied to any one company or sector.
- Low fees – Because index funds don’t need active management, they typically charge much lower fees than mutual funds. That leaves more of your return in your pocket.
- Simple to use – You don’t need to pick stocks or time the market. Index funds are easy to understand and work well for both beginners and long-term investors.
- Reliable performance – Index funds often keep pace with or outperform actively managed funds over time, especially once fees are factored in.
Cons
- Limited upside – Index funds aim to match the market, not beat it. If you’re looking for high-growth potential, this approach might feel too conservative.
- Market risk – Index funds rise and fall with the market. In a downturn, your investment will drop along with the index it tracks.
- No active decisions – These funds won’t adjust to short-term market trends or changing economic conditions. They stick to the index no matter what.
- Tracking error – A fund may not always match its index exactly. Differences in timing, fees, or strategy can cause small gaps in performance.
- Overconcentration risk – Some index funds give more weight to bigger stocks, which can mean less exposure to smaller companies with growth potential.
How to Get Started With Index Funds
- Set your goals – Decide what you’re investing for. Are you saving for retirement, building wealth, or putting money aside for a big expense?
- Pick your fund – Choose an index fund with low fees and broad market exposure. Look at long-term performance and make sure it matches your goals.
- Open an account – Use an online brokerage or robo-advisor. Many platforms offer commission-free index funds with low or no minimum investment.
- Start investing – Choose how much to invest and consider automating your contributions to stay consistent over time.
Best Index Funds for Beginners in 2025
If you’re just getting started, choosing a fund with low fees and broad market exposure can set you up for long-term success. Here are some of the most beginner-friendly index funds to consider:
- Vanguard Total Stock Market Index (VTSAX) – Offers exposure to the entire U.S. stock market, including small-, mid-, and large-cap stocks.
- Schwab U.S. Broad Market ETF (SCHB) – Delivers low-cost access to thousands of U.S. stocks with strong diversification.
- Fidelity ZERO Total Market Index (FZROX) – Has no expense ratio and no minimum investment, making it ideal for first-time investors.
- Vanguard S&P 500 ETF (VOO) – Tracks the S&P 500 with one of the lowest expense ratios in the industry.
- iShares Core S&P Total U.S. Stock Market ETF (ITOT) – Offers total market coverage with tight index tracking and low fees.
- Fidelity ZERO Large Cap Index (FNILX) – Focuses on large-cap stocks with no management fees or investment minimums.
- SPDR S&P 500 ETF Trust (SPY) – One of the oldest and most liquid ETFs, giving you broad market exposure with easy trading.
Final Thoughts
Index funds are one of the simplest, most reliable ways to invest. They cut out the guesswork, keep fees low, and give you exposure to a wide range of companies—all without needing to watch the market every day.
If you’re looking for steady growth without the stress, index funds offer a hands-off path to building long-term wealth. They may not be exciting, but they work. And when it comes to your money, that’s what really matters.
Frequently Asked Questions
Can I lose all my money in an index fund?
It’s unlikely, but not impossible. Since index funds are tied to the overall market, a total loss would require a near-complete collapse of that market. While short-term drops can happen, broad-based index funds tend to recover and grow over time.
How often should I check my index fund investments?
For most investors, once every few months is enough. Index funds are built for long-term growth, so frequent checking isn’t necessary and can even lead to emotional decision-making.
Do index funds pay dividends?
Yes, many index funds pay dividends if the companies in the index issue them. These dividends can be reinvested automatically or taken as cash, depending on your preference.
Is it better to invest in one index fund or multiple?
One well-diversified index fund may be enough, especially if it covers the total U.S. or global market. That said, some investors choose multiple funds to fine-tune their exposure to different sectors or regions.
What’s the best time to buy an index fund?
There’s no perfect time to buy. Index funds are meant for long-term investing, so consistent contributions—regardless of market conditions—tend to work better than trying to time the market.
