What Is an Index Fund? How Index Funds Work and What You Actually Own

You can own an index fund for years without anyone ever explaining what it is. An index fund is simpler than it sounds, and once you know how it works, you'll find it a lot easier to read your statement.

What is an index fund?

An index is a list of stocks or bonds. The S&P 500, for example, is a list of 500 leading U.S. companies. You can't buy a list. But you can buy an index fund, a fund that aims to match the list by buying the stocks or bonds on it. Some index funds buy everything on the list, and others buy only a sample.

A fund collects money from many people and invests it collectively. An index fund comes in one of two formats:

• A mutual fund. You buy mutual funds from the fund company or through a brokerage firm at a price that is set after the markets close each day.
• An ETF, or exchange-traded fund. An ETF trades on a stock exchange throughout the day with prices that can change during trading hours. You'll often need a brokerage account to invest in ETFs. That's an investment account at a brokerage firm that lets you buy and sell investments.

You own shares in the index fund. The fund owns the stocks. Each share is a small part of everything the fund holds. This arrangement spreads your risk across many companies. When the stocks in the fund rise or fall in value, your shares rise or fall with them.

No one at the fund is trying to pick winners. The manager follows the list. It's called passive investing, and it usually means less trading and lower fees.

Bigger companies often receive bigger investment slices. Market capitalization, or market cap, is a measure of a company's size. A company's market cap is its share price times the number of shares it has. Many indexes weigh each company by its size. Your money isn't evenly split in an index weighted in this way. A bigger company gets a bigger slice of each dollar you invest.

As companies grow or shrink in size, their slices grow or shrink with them. If the biggest companies grow faster than the rest, more of each dollar ends up with the largest companies.

Does it apply to you?

You may already own an index fund if you have a 401(k), a 403(b), or an IRA. A 401(k) or a 403(b) is a retirement plan offered through work, and you may have opened an IRA, or individual retirement account, yourself.

Your statement lists each fund by name. To check one, look for it on the fund's website or in its prospectus, the booklet that describes the fund. An index fund will state that its primary goal is to track a specific index.

Your numbers: what an index fund costs you

Funds charge an annual fee. It's called the expense ratio, and it represents the share of your money that the fund uses to cover its costs.

Let's assume you're 66 and have $20,000 in an IRA. You're choosing one of two funds that follow the same index. Fund A has an expense ratio of 0.10%. Fund B has a 0.75% expense ratio. These two fees are made up for this example.

• Fund A retains 0.10% of $20,000, or $20 a year.
• Fund B keeps 0.75% of $20,000, or $150 a year.

That means if you choose to invest in Fund B, you'll pay $130 more each year to invest in the same list of stocks. That amount adds up to $1,300 in ten years if your balance stays at $20,000. Find out how your balance could change at various rates and investment periods by using our compound interest calculator.

You'll never receive a bill for the costs. The fund deducts the fee from the fund's value, a little at a time. You'll see it as a slightly smaller balance.

An index fund can trail the index it follows partly because of the fees. Be aware, index funds don't always cost less than funds where the fund managers pick the stocks. Check yours.

A low fee can't protect you from market movements. An index fund faces the same risks as the stocks on its list. If those stocks drop 10%, your $20,000 will fall to about $18,000.

This 10% is only an example. The SEC warns investors that a stock fund's value can rise and fall quickly, even dramatically, in a short time.

No government agency insures index funds, not even the FDIC, the government agency that insures bank deposits. You can lose money on these investments.

What to do: find out what your funds charge

Look up the expense ratio for each fund in which you have money. FINRA, the organization that oversees brokerage firms, has an online Fund Analyzer that does the work for you. Choose up to three funds, enter the amount you plan to invest and for how long. The Fund Analyzer will show you how each fund's fees and expenses would affect your money over time.

If you prefer to find the answers in the paperwork, find the fee table in the fund's prospectus. You'll find the expense ratio on the line called "Total Annual Fund Operating Expenses."

Call FINRA's Securities Helpline for Seniors at 844-574-3577, weekdays from 9 a.m. to 5 p.m. Eastern, if you have any questions about an account. Don't take financial advice from just anyone. Find out who they are before you allow them to invest your money on your behalf. Our guide to fiduciary financial advisors shows you how.

This is general information, not investment advice.

Quick answers

Q: What is the difference between an index fund and an ETF? "Index fund" tells you what a fund does. The fund follows a list. "ETF" explains how the funds are packaged. ETFs trade on a stock exchange throughout the day. An index fund can be a mutual fund, priced once a day, or it could be an ETF.

Q: How do I invest in index funds? If your 401(k) has index funds on its list of choices, pick one. If you're investing in an IRA, you'll choose a company to hold the account, and that company will offer you a choice of funds. If you're looking for a regular investing account, you can open one at a brokerage firm or a fund company and buy fund shares there. Don't forget to check the expense ratio before you invest.

Q: Can you lose money in an index fund? Yes, you can lose money. An index fund carries the same risks as the stocks or bonds on its list, and it isn't insured. When the market falls, the fund falls too.

Sources

Checked October 15, 2026.

• SEC, Investor Bulletin: Index Funds (2018): what an index fund is; you can't invest directly in an index; some funds buy everything on it, others a sample; index fund managers aren't actively picking stocks; indexes often weigh companies by market cap, and what market cap is; not all index funds cost less than actively managed funds; an index fund carries the same risks as its index; fees can make a fund trail its index: investor.gov
• SEC, Investor.gov, Mutual Funds: a fund pools money from many investors; investing in a range of companies helps lower your risk if one company fails; you buy from the fund or through a broker; a share is part ownership of the fund; passive funds usually trade less and charge lower fees; fees come out of the fund's value; a stock fund's value can rise and fall quickly and dramatically; not insured by the FDIC or any other government agency: investor.gov
• SEC, Investor.gov, Exchange-Traded Funds: investors often need a brokerage account to trade them; not insured by the FDIC or any other government agency: investor.gov
• FINRA, Mutual Funds: mutual funds are priced once a day, when the markets close: finra.org
• FINRA, Exchange-Traded Funds and Products: ETFs trade all day like a stock: finra.org
• FINRA, Fund Analyzer: the tool, and FINRA's role overseeing brokerage firms: finra.org
• FINRA, Using the FINRA Fund Analyzer: compare up to three funds; what you enter: finra.org
• SEC, Investor.gov Glossary, Expense Ratio: what it is, and that it is in the prospectus fee table: investor.gov
• SEC, Investor Bulletin: Mutual Fund and ETF Fees and Expenses (2025): the "Total Annual Fund Operating Expenses" line: investor.gov
• SEC, Investor.gov, 401(k) Plans: a retirement plan offered by an employer: investor.gov
• SEC, Investor.gov, 403(b) and 457(b) Plans: retirement savings programs offered by certain employers: investor.gov
• SEC, Investor.gov, Individual Retirement Accounts: you open one yourself, choose a company to hold it, and pick from its investment choices: investor.gov
• SEC, Investor.gov, Brokerage Accounts: what a brokerage account is: investor.gov
• FDIC, Deposit Insurance: the FDIC insures bank deposits; mutual funds and stocks are not covered: fdic.gov
• S&P Dow Jones Indices, S&P 500: "500 leading companies": spglobal.com
• FINRA, Securities Helpline for Seniors: the phone number and hours: finra.org
• Arcanomy calculation: the yearly cost of 0.10% and 0.75% on $20,000, the 10-year gap at a flat balance, and a 10% drop on $20,000.