Ask ten people how to start investing and a good number will say “just buy an index fund.” It’s become the default advice for beginners, and for good reason. But it helps to know what you’re actually buying before you put money in.
The basic idea
A market index is just a list of investments that represents part of the market. The S&P 500, for example, tracks 500 large U.S. companies. An index fund is a mutual fund or exchange-traded fund (ETF) that simply buys everything on that list, in roughly the same proportions.
Nobody at the fund is trying to pick winners. That’s the point. You’re accepting the market’s return instead of trying to beat it — and because there’s no team of stock pickers to pay, costs stay low.
Why so many people recommend them
- Instant diversification. One share of a total-market fund can give you exposure to thousands of companies. If one goes bust, it barely registers.
- Low fees. Broad index funds commonly charge expense ratios well under 0.20% a year, and some charge a few hundredths of a percent. Over decades, that difference adds up — see our breakdown of expense ratios.
- Hard to beat. Year after year, a large share of actively managed funds trail their benchmark index after fees, especially over long periods.
- Low maintenance. You don’t have to research individual companies or watch the news every day.
Common types of index funds
- Total U.S. stock market — large, mid, and small U.S. companies together.
- S&P 500 — large U.S. companies only.
- International — developed and/or emerging markets outside the U.S.
- Bond index funds — government and corporate bonds, generally less volatile than stocks.
- Target-date funds — a mix of stock and bond index funds that gets more conservative as a chosen retirement year approaches.
How you blend these is called asset allocation, which we cover in asset allocation by age.
Mutual fund or ETF?
The same index can be tracked by either. ETFs trade throughout the day like stocks and often have no minimum beyond the price of one share (or a fraction, at many brokers). Index mutual funds trade once a day at the closing price and sometimes have a minimum initial investment. In a taxable account, ETFs are often slightly more tax-efficient. In a 401(k) or IRA, the difference mostly disappears.
The risks no one should skip over
An index fund is diversified, but it isn’t safe in the way a savings account is. When the market drops, your fund drops with it. Stock index funds have fallen more than 30% in a single year more than once in history. If you need the money in the next few years, it probably doesn’t belong in a stock fund.
Also, “index fund” doesn’t automatically mean cheap. Some funds tracking the same index charge far more than others. Always check the expense ratio before you buy. The SEC’s Investor.gov has a free tool and plain-language explanations of fund fees.
How to start
- Get your foundation in place: an emergency fund and a plan for high-interest debt.
- Pick the account. If your employer offers a match, your 401(k) usually comes first — here’s how a 401(k) match works. Otherwise, consider an IRA; we compare Roth and traditional IRAs here.
- Choose one or two broad funds. A total-market fund, or a single target-date fund, is a perfectly reasonable start.
- Automate contributions. Investing a set amount every month is called dollar-cost averaging, and it takes emotion out of timing.
- Leave it alone. Check in once or twice a year and rebalance if needed.
Before you open an account with any broker, it’s worth a quick search on FINRA’s BrokerCheck. For more strategy ideas, see our smart investment strategies for beginners.
The bottom line
Index funds aren’t exciting, and that’s exactly why they work for most people. They’re cheap, broad, and simple. The hard part isn’t choosing one — it’s staying invested when the market has a bad year.
This article is for education only and isn’t personalized investment advice.
