What is an index fund?
Last updated August 2026
Short answer
The idea sounds unambitious and that is the point. An index fund is designed to be average, cheaply, and average turns out to be a high bar once fees are counted.
What the fund actually does
An index is a published list with rules: the S&P 500 covers large US companies, a total-market index covers essentially all listed US companies, an international index covers companies outside the US.
The fund buys those securities in the proportions the index specifies. When a company enters or leaves the index, the fund follows. There is no judgment involved at any point.
Weighting is usually by market capitalisation, so larger companies occupy larger positions. A fund holding 500 companies can still be concentrated, because the biggest handful may account for a third of it.
Why it costs so little
Active management pays analysts, portfolio managers and data. Following a published list requires none of that.
Trading is also lighter. An index fund transacts when the index changes or when money moves in and out, rather than every time an opinion changes, and each trade has a cost that lands on shareholders.
Over decades the difference compounds. A percentage point a year on a portfolio held for thirty years is a large fraction of the final balance.
The evidence on performance
S&P Dow Jones Indices publishes the SPIVA Scorecard comparing active funds against their benchmarks. The Year-End 2025 US edition found 78.78% of active large-cap funds trailed the S&P 500 over one year.
Over longer horizons the figures worsen for the managers: 85.59% over ten years, 89.93% over fifteen and 92.89% over twenty.
The arithmetic explains it. Before costs, the average actively managed dollar earns roughly the market return, because collectively those managers are a large part of the market. After costs, it trails.
Try it in Walnut
Walnut reads your connected brokerage and shows what your funds actually hold, including how much overlap sits between two funds you thought were different.
Where index funds disappoint people
They fall with the market, fully. There is no manager to move to cash, and no protection in a downturn beyond whatever bonds you hold alongside.
They own everything in the list, including companies you would not choose. Index investing means owning the whole list on purpose.
Concentration arrives quietly. When a handful of companies dominate an index, a fund that sounds diversified can become a large bet on a few names without changing its strategy at all.
What to check before buying one
Which index it tracks. Two funds labelled US equity can hold quite different things, and the index rules are published.
The expense ratio, and whether the wrapper is a mutual fund or an ETF. That decides how it trades and, in a taxable account, how tax-efficient it tends to be.
Overlap with what you already own. Three funds tracking similar indexes are one position wearing three names, which is the most common accidental concentration in a retail portfolio.
Sources
Fund performance figures are from the SPIVA U.S. Scorecard, Year-End 2025, Report 1a, published by S&P Dow Jones Indices. General guidance on funds is published by the SEC at investor.gov. Walnut is informational and is not an investment adviser. This guide is educational and not personalized investment advice.
FAQ
What is an index fund in simple terms?
+
A fund that buys everything in a published list, in the proportions that list specifies, and does nothing else. An S&P 500 index fund holds those roughly 500 companies weighted by size, so its return matches the index minus a small annual fee.
Is an index fund the same as an ETF?
+
Not quite. Index fund describes the strategy, ETF describes the wrapper. Most ETFs track an index, and index funds exist as both mutual funds and ETFs. The practical difference is that ETFs trade during the day at market prices while mutual funds price once, after the close.
Why do index funds beat most professional managers?
+
Costs, mostly. The index is close to the average of everyone trading before fees, so the average active dollar must trail it by roughly what it charges. S&P Dow Jones Indices measured 92.89% of active large-cap US funds underperforming the S&P 500 over 20 years.
Are index funds risky?
+
They carry full market risk. A total-market index fund fell with everything else in 2008 and 2020, and it will again. What they remove is the risk of choosing badly among managers or individual stocks, not the risk of owning stocks.
How much should an index fund cost?
+
Broad US and global index funds are widely available under 0.10% a year, and several major ones sit near zero. Paying meaningfully more than that for a standard index means paying for something the fund is not delivering.
What is tracking error?
+
The gap between the fund's return and the index it follows, caused by fees, cash balances, sampling and trading costs. Small and consistent is normal. A fund whose tracking error is large or erratic is not doing the one job it exists to do.