Is an Index Fund a Mutual Fund? How They Relate
Yes, an index fund is a type of mutual fund
An index fund is a mutual fund that holds the same stocks (or bonds) as a market index — a published list of companies that represents some part of the market. The S&P 500 index, for example, tracks 500 large US companies. An S&P 500 index fund holds those same 500 companies in the same proportions, so its performance mirrors the index itself.
The key difference between an index fund and other mutual funds is not what it is, but how it is managed. Most mutual funds employ a manager or team who pick which stocks to buy and sell, trying to beat the market. Index funds do not try to beat the market — they simply copy it. This difference affects what you pay, how often the holdings change, and what returns you can expect.
Key Takeaways
- Index funds are mutual funds that track a published market index rather than relying on a manager to pick individual stocks.
- Because index funds do not require active management, they typically charge lower fees than actively managed mutual funds.
- Index funds hold the same securities as their index, so their performance will closely match the index's performance minus fees.
- You can find index funds as mutual funds or as ETFs, which are a separate investment type that tracks indexes in a different way.
How index funds differ from actively managed mutual funds
An actively managed mutual fund pays a manager to research companies, decide which ones to buy, and decide when to sell. The manager's goal is to pick stocks that will outperform the market. This requires research, trading, and constant decisions — all of which cost money. Actively managed mutual funds typically charge between 0.5% and 2% per year in fees.
An index fund has no manager making those decisions. Instead, it simply holds the stocks in its index. When the index changes — when a company is added or removed — the index fund adjusts its holdings to match. This is mostly automatic and requires far less work. Index funds typically charge between 0.03% and 0.20% per year, sometimes called the expense ratio.
Over long periods, those fee differences compound. On a $10,000 investment, paying 1.5% per year instead of 0.10% costs you thousands of dollars over 20 or 30 years, even if both funds earn the same return before fees.
What indexes exist and what they track
An index is simply a list of securities and their weights — how much of the index each one represents. The most common indexes track US stocks, but indexes exist for nearly every market segment. Here are the ones you will encounter most often:
- S&P 500: 500 large US companies, weighted by market value. This is the broadest measure most people use for "the stock market."
- Total Stock Market Index: All US stocks, including mid-size and small companies. Broader than the S&P 500.
- Nasdaq-100: 100 large technology and growth companies. More concentrated in tech than the S&P 500.
- Bond indexes: Collections of bonds grouped by type (government, corporate, short-term, long-term). An index fund can track bonds just as easily as stocks.
- International indexes: Stocks from specific countries or regions outside the US.
Index funds exist for nearly all of these. When you choose an index fund, you are choosing which index it tracks — and therefore which slice of the market you own.
Index funds as mutual funds versus index funds as ETFs
Index funds come in two legal structures: mutual funds and exchange-traded funds (ETFs). Both track an index, both charge low fees, and both hold the same underlying securities. The differences are in how you buy them and when you can trade them.
An index mutual fund is priced once per day, after the market closes. You place an order during the day, but you do not know the exact price until the close. You can set up automatic monthly investments, and many have low or no minimum investment amounts. Index ETFs trade throughout the day like stocks, so you see the price in real time and can buy or sell at any moment. ETFs often have lower expense ratios than mutual funds tracking the same index, but you pay a trading commission each time you buy or sell (though many brokers now offer commission-free ETF trading).
For most individual investors building a long-term portfolio, the choice between an index mutual fund and an index ETF comes down to convenience and the fees your broker charges. If your broker offers commission-free ETF trading, an ETF often costs less. If you want to set up automatic monthly investments without thinking about it, a mutual fund may be simpler.
Why investors choose index funds
Index funds appeal to investors for three main reasons: low cost, predictable performance, and simplicity. Because they do not require active management, they charge much less than actively managed funds. Because they hold the same securities as their index, their performance is predictable — you know you will match the index's return minus a small fee, rather than hoping a manager will beat the market.
Research on actively managed mutual funds shows that most do not beat their index over long periods, especially after fees. An investor who picks an index fund knows they are getting market-level returns at a low cost, rather than paying high fees for a manager who may underperform. This is why index funds have grown to hold trillions of dollars.
Index funds also require less attention. You do not need to monitor whether your manager is making good decisions or whether it is time to switch to a different fund. You simply hold the index fund and let it track the market.
Building a portfolio with index funds
Many investors build entire portfolios using only index funds. A simple three-fund portfolio might hold a total US stock index fund, an international stock index fund, and a bond index fund — giving you exposure to stocks across the world and to bonds, all at low cost.
Index funds can also be mixed with actively managed funds or individual stocks if you prefer. Some investors use index funds as the core of their portfolio — the stable, low-cost foundation — and add actively managed funds or individual stocks around the edges if they want to try to beat the market in specific areas.
The key is understanding that an index fund is a tool for owning a slice of the market at low cost. Whether that tool is right for you depends on your goals, your time horizon, and how much attention you want to pay to your investments.
Frequently Asked Questions
Can an index fund underperform its index?
Yes, slightly. An index fund will always lag its index by roughly the amount of its expense ratio, because the fund's fees come out of returns. A fund tracking the S&P 500 with a 0.10% expense ratio will return about 0.10% less per year than the index itself. This is expected and normal.
Do index funds ever change what they hold?
Yes, but only when the index itself changes. When a company is added to or removed from an index, the index fund adjusts its holdings to match. This happens infrequently — the S&P 500, for example, changes only a few times per month. The fund does not trade based on market conditions or a manager's opinion.
Is an index fund the same thing as a target-date fund?
No. A target-date fund is a mutual fund that holds a mix of index funds and actively managed funds, automatically shifting the mix as you get closer to retirement. It is a fund of funds. An index fund holds individual securities (stocks or bonds) directly and tracks a single index.
What is the difference between an index fund and a stock index fund?
An index fund can track any index — stocks, bonds, or a mix. A stock index fund specifically tracks an index of stocks. There are also bond index funds, which track bond indexes. The term "index fund" is broader; "stock index fund" is more specific.
Can I lose money in an index fund?
Yes. An index fund's value rises and falls with the index it tracks. If the stock market drops 20%, an S&P 500 index fund will also drop roughly 20%. Index funds are not may provide investments. Over long periods, stock markets have historically trended upward, but short-term losses are normal and possible.