In a few words…
An index fund is an investment fund designed to match the return of a given stock or bond market index.
Going a bit deeper…
An index fund seeks the same return as the overall stock or bond market. Index funds operate at a lower cost compared to typical mutual fund models, which buy and sell investments regularly.
For instance, an actively managed mutual fund might own 20 to 50 stocks. It then trades in and out those positions on a weekly or monthly basis.
In comparison, an index fund owns hundreds or even thousands of stocks. It trades only to reflect the weight of those stocks in the index itself.
Because they are automated, index funds are very low cost. The return on an index fund will not exceed the overall market.
However, it also will not underperform the market, except for its very low fees.
In the words of an expert advisor…
An index fund is any kind of fund that tries to match a market index, which could be an equity index or a fixed-income index. It doesn’t matter which.
Where does an index fund fit into an overall portfolio? Assume you’re going to be invested for a long period of time. Even if you’re 70 now, that could be 15 years.
If that’s the case you want to stack the odds in your favor, which index investing can achieve.
Investing in index funds means that odds are you’re going to do better than almost everybody. You’re not going to get a market-beating performance, but you will get a result that’s hard to beat.
Alternatively, you could do “core and explore,” that is, hold index funds and create a small portfolio of stocks to trade for fun. That’s okay.
But since there’s no systematic way to pick winners ahead of time, you should know that most of your performance over time will come from the index fund portion of your portfolio.