What an index fund is

This page describes what the thing is. It does not tell you whether to own one — that depends on your circumstances, your timeframe and your tax situation, none of which a web page knows.

Start with the index

An index is a list of companies plus a rule for how much of each counts. The S&P 500 is roughly the 500 largest listed companies in the United States, weighted by market value. The FTSE 100 is roughly the 100 largest on the London exchange. A "total world" index is several thousand companies across many countries.

An index is not a product. It is a published measurement — a way of saying "this is what that slice of the market did today".

Then the fund

An index fund is a pooled investment that buys the constituents of an index in the index's proportions. You put money in; it buys a sliver of every company on the list; your holding rises and falls with the index, minus costs.

The defining feature is what it does not do: nobody is deciding which companies look promising. The fund holds what the index says to hold. When a company leaves the index, the fund sells it. That is the whole operating procedure, and it is why these funds can be run cheaply — there is no research department to pay for.

The contrast with an active fund

An actively managed fund employs people to select holdings, aiming to do better than the index. That is a genuine service and it costs money — typically several times what an index fund charges.

The arithmetic worth knowing: the market's total return is, by definition, the average return of everyone invested in it, before costs. So collectively, active investors cannot beat the market by more than the market returns — after fees, the average active pound must trail the average index pound by roughly the difference in cost. Individual funds can and do beat their index; identifying which ones will do so in advance is the hard part, and this site takes no position on how hard.

The fee calculator shows what the cost difference does over decades, holding the pre-fee return equal. It is not an argument that active funds return less before costs; it isolates the charge.

Terms you will run into

• ETF — an index fund traded on an exchange like a share, priced continuously through the day. Mechanically similar to a traditional index fund; the difference is how you buy it.
• Accumulating vs distributing — accumulating reinvests dividends inside the fund; distributing pays them out. Accumulating is what a compound growth projection implicitly assumes.
• Tracking error — how far the fund's return drifts from the index it follows. Small for large mainstream funds.
• OCF / expense ratio — the annual charge, deducted inside the fund. You never see a bill.

What an index fund does not protect you from

Diversification across hundreds of companies removes the risk of any one of them failing. It does not remove the risk of the market as a whole falling, and index funds fall hard in a downturn — that is what tracking means. Nor does spreading across many companies in one country protect against that country having a poor few decades.

The smooth curves in the calculators here look nothing like the year-to-year experience of holding one of these. That gap is the thing to internalise before acting on any projection.