What an S&P 500 Index Fund Does and Why Investors Use It

An S&P 500 index fund holds the same 500 large US companies that make up the S&P 500 benchmark

An S&P 500 index fund is a fund that tracks the S&P 500, a list of 500 of the largest publicly traded companies in the United States. When you own shares in an S&P 500 index fund, you own a small piece of all 500 companies at once. The fund automatically rebalances to stay aligned with the index — if a company is added to or removed from the S&P 500, the fund adjusts its holdings to match.

The S&P 500 includes companies like Apple, Microsoft, Nvidia, Berkshire Hathaway, and Eli Lilly, along with 495 others across industries like technology, healthcare, finance, energy, and consumer goods. Because the fund holds such a wide range of large, established companies, it spreads your money across many different businesses and sectors rather than concentrating it in a few.

The fund's value rises and falls with the overall performance of those 500 companies. If the companies in the index earn more profit and grow, the fund's value grows. If they struggle, the fund's value declines. You are not betting on any single company — you are betting on the broad US economy.

Key Takeaways

• An S&P 500 index fund holds all 500 companies in the S&P 500 index, giving you exposure to a wide range of large US companies in one purchase.
• The fund's performance tracks the index closely, so your returns will roughly match what the S&P 500 returned over the same period.
• S&P 500 index funds charge low fees — typically between 0.03% and 0.20% per year — because they simply hold the same companies as the index rather than trying to beat it.
• You can buy S&P 500 index funds through a brokerage account, a retirement account like an IRA or 401(k), or through a robo-advisor.
• The fund is designed for long-term holding; short-term traders may see large swings in value, but the historical trend over decades has been upward.

How an S&P 500 index fund differs from actively managed funds

An S&P 500 index fund does not try to beat the market. A fund manager does not pick which 500 companies to hold or decide when to buy and sell them. Instead, the fund simply holds the same companies as the S&P 500 index and rebalances when the index changes. This passive approach keeps costs low.

An actively managed fund, by contrast, employs a manager or team that researches companies, makes buy-and-sell decisions, and aims to outperform the index. That research and active trading cost money, so actively managed funds charge higher fees — often 0.5% to 1.5% or more per year. Over time, those higher fees eat into returns. Many actively managed funds do not beat the S&P 500 even before fees are subtracted.

For most investors, the lower cost and predictable performance of an index fund makes it a simpler choice than trying to pick a manager who will beat the market.

What you pay to own an S&P 500 index fund

The main cost of owning an S&P 500 index fund is the expense ratio, the annual fee charged as a percentage of your investment. For S&P 500 index funds, this typically ranges from 0.03% to 0.20% per year. That means on a $10,000 investment, you would pay between $3 and $20 per year.

Different fund companies charge different rates. Vanguard's S&P 500 ETF (ticker: VOO) charges 0.03%. Fidelity's S&P 500 index fund (ticker: FSKAX) charges 0.015%. Schwab's S&P 500 index fund (ticker: SWTSX) charges 0.03%. These are among the lowest-cost options available. Some funds charge more, but the difference compounds over decades.

You may also pay a transaction fee when you buy or sell shares, though many brokerages now offer commission-free trading on index funds. Check your brokerage's fee schedule before you open an account.

Where to buy S&P 500 index funds

You can buy S&P 500 index funds through a regular brokerage account at firms like Fidelity, Vanguard, Charles Schwab, or E*TRADE. You can also hold them in a retirement account — an IRA, Roth IRA, or 401(k) — where they often grow tax-deferred or tax-free depending on the account type.

If you do not want to pick individual funds yourself, a robo-advisor like Betterment or Wealthfront will build a portfolio that includes S&P 500 index funds alongside other investments, then rebalance automatically. Robo-advisors charge a management fee on top of the fund's expense ratio, so this approach costs more than buying the fund directly, but it removes the need to make decisions.

Many employers also offer S&P 500 index funds as an option within their 401(k) plan. If your plan offers one, it is often a solid core holding for your retirement savings.

How S&P 500 index funds perform over time

The S&P 500 has returned an average of roughly 10% per year over the past 50 years, though returns vary significantly from year to year. Some years the index rises 20% or more; other years it falls 10% or more. Over longer periods — 10, 20, or 30 years — the ups and downs tend to smooth out, and the long-term trend has been upward.

An S&P 500 index fund will track this performance closely. If the S&P 500 returned 15% in a given year, your fund should return approximately 15% minus its expense ratio. Because the expense ratio is so small, the fund's return will be nearly identical to the index's return.

Past performance does not predict future results. The index could perform differently in the future than it has in the past. But the historical record shows that holding a diversified portfolio of large US companies for the long term has been a reliable way to build wealth.

Why investors choose S&P 500 index funds

Investors use S&P 500 index funds for several reasons. First, they provide instant diversification — one purchase gives you exposure to 500 companies instead of forcing you to pick individual stocks. Second, the fees are very low, which means more of your money stays invested and compounds over time. Third, they require no ongoing decisions; you buy and hold, and the fund handles the rebalancing.

S&P 500 index funds are also a good foundation for a broader portfolio. Many investors hold an S&P 500 index fund as their core US stock holding, then add other funds for international stocks, bonds, or real estate to diversify further. Because the S&P 500 represents about 80% of the total US stock market by value, holding an S&P 500 fund alone gives you exposure to most of the large US economy.

For beginners, S&P 500 index funds are often recommended as a starting point because they are simple, low-cost, and do not require you to research individual companies or time the market.

S&P 500 index funds versus individual stocks

Buying an S&P 500 index fund is different from buying individual company stocks. When you buy a stock, you own a piece of one company and your return depends entirely on how that company performs. When you buy an S&P 500 index fund, you own a piece of 500 companies, so poor performance by one company has a small effect on your overall return.

Individual stocks can offer higher returns if you pick winners, but they also carry higher risk. You might pick a company that fails or underperforms. An index fund smooths out that risk by holding many companies at once. Most individual investors do not consistently pick stocks that beat the index, so an index fund is often the more reliable choice.

Some investors hold both — a core position in an S&P 500 index fund for stability and diversification, plus a smaller allocation to individual stocks they research and believe in. This approach lets you participate in the broad market while still having the option to make individual bets.

Frequently Asked Questions

Can I lose money in an S&P 500 index fund?

Yes. If the S&P 500 declines in value, your fund will decline as well. The index has fallen in some years, and it can fall sharply during recessions or market downturns. However, historically the index has recovered from every decline and reached new highs over longer time periods. If you need the money in the next few years, an index fund may be too risky; if you can hold for 10+ years, the historical trend suggests recovery is likely.

What is the difference between an S&P 500 index fund and an S&P 500 ETF?

Both track the S&P 500, but they are structured differently. A mutual fund is priced once per day after the market closes; an ETF trades throughout the day like a stock. ETFs often have slightly lower expense ratios and may be more tax-efficient. For most long-term investors, the difference is small. Both are good choices; pick whichever your brokerage makes easiest to buy.

Should I invest in an S&P 500 index fund or a total US stock market index fund?

An S&P 500 fund holds the 500 largest US companies. A total US stock market fund holds those 500 plus thousands of smaller companies. The S&P 500 fund is simpler and captures most of the market's value; the total market fund is more diversified but includes smaller, riskier companies. Either works for most investors. The S&P 500 is a good starting point if you are unsure.

Can I buy an S&P 500 index fund in a retirement account?

Yes. Most IRAs, Roth IRAs, and 401(k) plans offer at least one S&P 500 index fund option. Holding an index fund in a retirement account is common and often recommended because the tax-deferred or tax-free growth compounds over decades. Check your plan's available funds to see which S&P 500 option is offered.

What happens if a company is removed from the S&P 500?

When a company is removed from the index, the fund automatically sells its shares in that company and buys shares in the company that replaces it. You do not need to do anything — the fund manager handles the rebalancing. This happens infrequently, and the impact on your returns is usually small.