What are index funds and how to invest in them 

What is a financial index?

Before we dive into index funds and how they work, we first need to understand what a financial index is. Most of us have heard of the S&P 500 or Dow Jones Industrial Average, but what are they, exactly?

A financial index is a numerical benchmark of a specific group of securities that allows investors to quickly understand or measure how certain parts of the global financial market are performing.

For example, if you want to understand how the tech sector did last week, instead of tracking down every tech company’s stock price, marking the performance of each, and adding it all up yourself, you could simply look at the Nasdaq-100 Technology Sector Index. Or, if you want to measure how your retirement portfolio performed last year against the overall U.S. stock market, you can compare your growth to the Dow Jones U.S. Total Stock Market Index, which accounts for the top 95% of traded companies.

There is no set number of financial market indices and new ones are created all the time, but here is a list of the most commonly used in the U.S.:

• S&P 500: Tracks the 500 largest U.S. companies and is considered an indicator of the overall U.S. economy.
• Dow Jones Industrial Average: Tracks 30 large-cap, publicly owned companies in the U.S.
• Nasdaq Composite: Tracks most of the Nasdaq stock exchange and is more concentrated on technology and growth companies.
• Russell 2000: Tracks the performance of U.S. small-cap companies (under $2 billion market cap).
• NYSE Composite: Tracks all common stocks listed on the New York Stock Exchange.
• Wilshire 5000: Tracks every U.S.-headquartered stock.

How do index funds work?

An index fund is usually a type of mutual fund or exchange-traded fund (ETF). A fund is simply a basket of many different assets that you can buy a part of. Some funds are actively managed by professional investors and aim to beat the market, to varying degrees of success. Actively managed funds also come with additional fees that can eat into your returns. The goal of an index fund is different—to mirror the growth of a specific market index with as little work as possible. Usually, this is accomplished by having a representative sample of all the securities within that index.

Index funds are often called passive investing, and that is meant as a good thing. You’re not trying to “beat the market” or make significant gains year over year. Instead, you’re relying on the steady growth of the overall market over many years. It’s a long-term investment strategy that many employ in their retirement accounts, such as 401(k)s and IRAs. In fact, as of 2023, index funds accounted for 48% of assets managed by investment firms, up from only 19% in 2010.¹

Are index funds different from mutual funds and ETFs?

Yes, and no. Most index funds are either a mutual fund or an ETF. It’s easiest to think of it this way:

A mutual fund or ETF is an investment vehicle.
An index fund is a strategy that can go inside either a mutual fund or ETF.

There are thousands of different mutual funds, and ETFs are a fast-growing sector. They share many similarities but have subtle differences in how they are bought and sold. Both mutual funds and ETFs can have varied strategies and goals. For example, you can purchase a fund that holds only commodities like gold and oil, or a fund that specializes in dividends. Index funds are a specific strategy rather than a different vehicle. See index funds vs. mutual funds for more.

Do index funds have high fees?

It’s possible that some index funds have higher fees, but generally, index funds are known for their low costs. Every fund has numerous fees that usually get wrapped up into one number, called the expense ratio. These ratios generally range from .05% to .27%.² This is the yearly cost you pay to the fund manager to own that fund, represented as a percentage of your holdings. For example, if you have $10,000 in a fund with a 2% expense ratio, you’d pay $200 each year. The difference between 2% and .02% may not seem like much, but it can be a significant factor over time, due to compounding interest on your investments. You should be able to clearly see this information wherever you invest in these funds.

Low-cost index funds

While many index funds will offer lower expense ratios than most other mutual funds and ETFs, there are specific funds that aim to be as low as possible. There are even options that have a 0% expense ratio. However, expense ratio cost should not be the only determining factor in your selection process.

Pros and cons of index funds

Index funds are widely seen as stable long-term investments, but like all investments, they still come with drawbacks and risk. They provide less flexibility and control and can still be subject to losses when markets do poorly. You should always consult with a qualified financial professional before making big decisions about your portfolio. Here are some of the pros and cons associated with index funds:

How to invest in index funds

Starting to invest in index funds is relatively straightforward and beginner-friendly. If you already have a retirement account like a 401(k) or IRA, or a standard brokerage account, you just have to select the index fund you want and start contributing to it. Learn more about how to start investing.

Index funds in a 401(k) or IRA

Typically, in these types of tax-advantaged retirement accounts, you’ll have options for different types of mutual funds, including index funds, although they are still often limited. Even if you’ve never logged in or made a selection, your account is already invested in something. Once you are logged into your retirement account website, you can change your current investments or update future contributions from a list. The names of funds are often a string of letters and numbers that may not make immediate sense to you, but any with “INDEX” in the name should be an index fund. You can usually click on the name to get more information, like historical performance and expense ratios.

Other ways to invest in index funds

You can also invest post-tax dollars in nearly any index fund you want with a standard brokerage account. This gives you flexibility and diversification with the added benefit of no contribution or withdrawal limits. However, when you do sell investments, even index fund shares, they are subject to capital gains taxes, so it’s important to consider the tax implications as part of your overall strategy.

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

You don’t need a lot of money to start investing in mutual funds. If you’re investing in a retirement plan like a 401(k) or IRA, there often is no minimum, and your contributions, as well as your employer match, go directly into the fund. If you are investing directly, the minimum will depend on the specific fund. Some may allow the purchase of fractional shares and can be accessed with as little as $10 to $100 to invest. Other funds might have minimums of $3,000 or more.

Index fund investing FAQs

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¹“How I Stopped Worrying and Learned to Love Index Funds,” Cato Institute, 2025
²“Trends in Expenses and Fees of Funds,” Investment Company Institute, 2025.