What is an index fund and how does it work?

An index fund is a type of investment that holds all (or a representative sample of) the stocks or bonds in a specific market index, like the S&P 500. Instead of trying to pick winning stocks, it mirrors the performance of the entire index. When the S&P 500 goes up 10%, an S&P 500 index fund goes up roughly 10% minus a tiny fee.

How much money do I need to start investing in index funds?

Many brokerages now have no minimum investment for index funds, and most support fractional shares, meaning you can start with as little as $1. Fidelity, Schwab, and Vanguard all offer zero or low minimum index funds. There is no amount too small to begin.

Are index funds better than individual stocks?

For most people, yes. Index funds provide instant diversification across hundreds or thousands of companies, charge very low fees, and historically outperform the majority of actively managed funds and individual stock pickers over long periods. About 90% of actively managed funds underperform their benchmark index over 15 years.

What is the difference between an index fund and an ETF?

An index fund can be structured as either a mutual fund or an ETF (exchange-traded fund). Index mutual funds are bought at end-of-day prices and may have minimums. Index ETFs trade like stocks throughout the day, have no minimums (you buy by the share or fractional share), and are generally more tax-efficient. Both can track the same index.

What is a good index fund for beginners?

A total stock market index fund like VTI (Vanguard Total Stock Market ETF) or FSKAX (Fidelity Total Market Index) is an excellent starting point. It gives you exposure to the entire U.S. stock market in one investment. For even broader diversification, pair it with an international index fund like VXUS.

Index Fund Investing for Beginners: The Simple Path to Wealth

What Is an Index Fund?

An index is a list of companies grouped by some criteria. The S&P 500, for example, tracks the 500 largest U.S. companies. The total stock market index covers essentially every publicly traded U.S. company.

An index fund simply buys all the stocks in that index, in the same proportions. When you invest in an S&P 500 index fund, you own a tiny piece of Apple, Microsoft, Amazon, JPMorgan, Johnson & Johnson, and about 495 other companies — all in one purchase.

You don’t pick stocks. You don’t analyze earnings reports. You just own the market.

Why Index Funds Beat Most Alternatives

The Data Is Overwhelming

According to the SPIVA scorecard (S&P Indices Versus Active), over a 15-year period, approximately 87% of large-cap U.S. fund managers failed to beat the S&P 500 index. Over 20 years, the number climbs even higher.

These are professional money managers with teams of analysts, advanced tools, and decades of experience. And the vast majority of them can’t consistently beat a simple index fund.

Fees Matter More Than You Think

The average actively managed mutual fund charges about 0.50-1.00% annually. The average index fund charges 0.03-0.20%.

That difference sounds tiny, but watch what happens over 30 years on a $100,000 portfolio growing at 7%:

Fee Level	30-Year Value	Lost to Fees
0.03% (index fund)	$754,000	$7,000
0.50% (average active)	$661,000	$100,000
1.00% (expensive active)	$574,000	$187,000

A 1% fee costs you $187,000 over 30 years. That’s not a rounding error — it’s a house.

Built-In Diversification

Buying individual stocks concentrates your risk. If you put everything in one company and it tanks, you lose big. An S&P 500 index fund spreads your money across 500 companies. Even if several fail, the others carry the weight.

A total stock market fund goes further, covering small-cap and mid-cap companies too. Add an international index fund, and you’re invested in thousands of companies across the globe.

Types of Index Funds You Should Know

By Market Coverage

S&P 500 Index Fund: Tracks the 500 largest U.S. companies. The most popular index fund category. (Examples: VOO, SPY, FXAIX)

Total Stock Market Index Fund: Tracks the entire U.S. stock market — large, mid, and small companies. Broader than S&P 500. (Examples: VTI, SWTSX, FSKAX)

International Index Fund: Tracks companies outside the U.S. Provides global diversification. (Examples: VXUS, IXUS, FTIHX)

Bond Index Fund: Tracks a broad index of bonds. Less volatile than stocks, provides stability and income. (Examples: BND, AGG, FXNAX)

By Structure

Index Mutual Fund: Bought and sold at end-of-day price. May have investment minimums ($1,000-$3,000 at some brokerages). Good for automatic investing.

Index ETF: Trades like a stock during market hours. No minimums (buy by the share). Slightly more tax-efficient. Good for flexibility.

Both track the same indexes. The choice between them is mostly about convenience and your brokerage’s offerings.

The Three-Fund Portfolio

The simplest, most effective portfolio for most investors uses just three index funds:

U.S. Total Stock Market Index Fund (60-80% of portfolio)
International Stock Market Index Fund (10-30% of portfolio)
U.S. Bond Index Fund (0-20% of portfolio, more as you age)

That’s it. Three funds covering the entire global market. This approach was popularized by Bogleheads (followers of Vanguard founder Jack Bogle) and has decades of evidence behind it.

Sample Three-Fund Portfolios by Age

Age 20-35

70% U.S. stocks
20% International
10% Bonds

Age 35-50

60% U.S. stocks
20% International
20% Bonds

Age 50-65

45% U.S. stocks
15% International
40% Bonds

How to Start Investing in Index Funds (Step by Step)

Step 1: Open a Brokerage Account

You need an account to buy index funds. Here are the best options for beginners:

Fidelity: No minimums, excellent index funds (many with 0% expense ratios), great research tools
Vanguard: The original index fund company, investor-owned, very low fees
Charles Schwab: No minimums, strong platform, excellent customer service

All three are reputable, have no account fees, and offer a wide selection of index funds. Opening an account takes about 15 minutes online.

Which account type? If you have a workplace 401(k), invest there first up to the employer match. Then open a Roth IRA for additional investing. For our full IRA breakdown, read Roth IRA vs Traditional IRA.

Step 2: Decide How Much to Invest

There’s no minimum that makes sense and no amount that’s “too small.” But here are guidelines:

$50-100/month: A great starting point for beginners
$200-500/month: Solid wealth-building pace
$500+/month: Aggressive growth (max your IRA at $583/month)

The most important thing is consistency, not the amount. For strategies on getting started with a small budget, see how to start investing with $100.

Step 3: Pick Your Fund(s)

For complete beginners, start with one fund: a total stock market index fund or an S&P 500 index fund. You can add international and bonds later.

Popular starter picks:

Fund	Type	Expense Ratio
VTI (Vanguard)	Total U.S. Stock Market ETF	0.03%
FSKAX (Fidelity)	Total Market Index Mutual Fund	0.015%
SWTSX (Schwab)	Total Stock Market Index	0.03%
VOO (Vanguard)	S&P 500 ETF	0.03%
FXAIX (Fidelity)	S&P 500 Mutual Fund	0.015%

Step 4: Set Up Automatic Investing

Most brokerages let you schedule automatic purchases on a recurring basis. Set it up on payday and forget about it. This is called dollar-cost averaging, and it removes the temptation to time the market. We explain the full strategy in our dollar-cost averaging guide.

Step 5: Don’t Touch It

Seriously. The hardest part of index fund investing is doing nothing when the market drops. Historically, the stock market has recovered from every single downturn. The people who lose money are the ones who panic-sell during dips.

Pennie’s Rule

If looking at your portfolio during a market drop makes you anxious, stop looking. Check it once a quarter, rebalance once a year, and otherwise leave it alone. The people who check daily make worse decisions than the people who check annually.

Common Index Fund Mistakes to Avoid

Trying to time the market. “I’ll wait for a dip” is a losing strategy. Research consistently shows that time in the market beats timing the market. Missing just the 10 best days in a 20-year period can cut your returns in half.

Chasing past performance. A fund that returned 30% last year won’t necessarily repeat that. Index funds are about capturing broad market returns, not chasing hot sectors.

Over-diversifying. Owning 15 different index funds that overlap (three different S&P 500 funds, for example) adds complexity without benefit. Two or three funds is enough.

Paying high fees. If an “index fund” charges more than 0.20%, look for a cheaper alternative. The difference compounds dramatically over time.

Selling during downturns. Market drops of 10-20% happen regularly. Drops of 30%+ happen every decade or so. Every single time, the market has recovered and gone higher. Selling during a drop locks in losses.

Index Funds vs. Other Investment Options

Option	Average Annual Return	Fees	Effort	Risk
Index Funds	7-10% (historical)	Very low (0.03-0.20%)	Minimal	Moderate (market risk)
Active Mutual Funds	5-8% (after fees)	High (0.50-1.50%)	Low	Moderate
Individual Stocks	Highly variable	Low per trade	High	High
Savings Account	4-5% (current HYSA)	None	None	Very low
Real Estate	8-12% (variable)	High (maintenance, taxes)	Very high	Moderate-high

For most people with a 10+ year time horizon, index funds offer the best combination of returns, low fees, and minimal effort.

The Power of Staying the Course

The S&P 500 has returned an average of about 10% annually (before inflation) since 1957. That includes crashes, recessions, pandemics, wars, and every other crisis.

If you invested $300/month in an S&P 500 index fund starting in 1994, stayed invested through the dot-com crash, the 2008 financial crisis, and the 2020 pandemic crash, you’d have over $750,000 by 2024. Your total contributions: $108,000. Compounding and patience did the rest.

Get Started Today

Here’s your action plan:

This week: Open a brokerage account (Fidelity, Vanguard, or Schwab)
After funding: Buy your first index fund (VTI, FSKAX, or equivalent)
Set and forget: Schedule automatic monthly contributions
Once a year: Check your allocation and rebalance if needed
For 20+ years: Stay invested, ignore the noise, and let compounding work

Index fund investing isn’t exciting. It’s not going to make you rich overnight. But it’s the strategy that’s made more ordinary people wealthy than any other approach in history.

Disclaimer: This content is for educational purposes only and is not personalized financial, legal, or tax advice. All investing involves risk, including the potential loss of principal. Past performance does not guarantee future results. The funds mentioned are examples, not recommendations. See our full disclaimer.