An index fund is a type of investment fund designed to track the performance of a specific market index — a defined basket of stocks or bonds — rather than trying to pick individual winners.
How it actually works
When you invest in an index fund tracking a broad stock market index, your money is spread across every company in that index, roughly in proportion to each company's size. Instead of betting on one company outperforming, you're effectively betting on the overall market — or a segment of it — going up over time.
Why they became so popular
- Lower fees — because there's no research team picking stocks, operating costs are typically much lower than actively managed funds.
- Diversification — a single fund can hold hundreds or thousands of underlying companies.
- Track record — over long time horizons, a majority of actively managed funds have historically underperformed their benchmark index after fees.
What to actually check before buying one
| What to check | Why it matters |
|---|---|
| Expense ratio | An annual fee taken as a percentage of your investment — smaller differences compound significantly over decades. |
| Which index it tracks | Different indexes have very different risk profiles — a total market index differs a lot from a narrow sector index. |
| Fund size and age | Larger, more established funds tend to have tighter tracking and lower trading costs. |
Index funds still carry market risk
"Diversified" does not mean "risk-free." An index fund can still lose significant value during a broad market downturn — diversification spreads risk across companies, it doesn't eliminate market-wide risk.
Index investing isn't the only reasonable approach to building wealth, but its simplicity and historically low costs are why it's so frequently recommended as a starting point for new investors.
About the author
Daniel Osei
Business & Finance Correspondent
11 pieces published
