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What is an index fund, and is it a good first investment?
by financebrain · October 20, 2026
An index fund is a fund that copies a market index, such as the S&P 500, instead of trying to beat it. It buys the investments in the index in the same proportions and only changes them when the index changes. You get the market's return, minus a small fee.
Index funds are a common first investment for three reasons. They're cheap, they spread your money across many companies at once, and they've beaten most professional fund managers over long periods. They still rise and fall with the market, so they suit money you won't need for years, not your emergency fund.
A short history
John Bogle launched the first index fund for ordinary investors at Vanguard in 1976, tracking the S&P 500. Critics mocked it at the time for "settling for average". By the mid-2020s, index funds and their exchange-traded cousins held more than half of all US mutual fund assets.
Index funds vs actively managed funds
| Index fund | Actively managed fund | |
|---|---|---|
| Goal | Match the index | Beat the index |
| Typical yearly fee (expense ratio) | 0.03–0.20% | 0.60–1.20% or more |
| What it holds | Exactly what the index holds | Whatever the manager picks |
| Long-run record | The index return, minus a small fee | 80–90% underperform their index over 15 years |
That last row comes from S&P's long-running SPIVA reports. Accepting the market return means you beat most of the managers trying to outdo it, because their higher fees eat into any edge they have.
Why fees matter so much
A fee sounds small as a percentage. But it's taken every year from a balance that keeps growing, so it compounds just like returns do.
Take a hypothetical $100,000 left for 30 years:
- At 7% a year, it grows to about $761,000.
- At 6% a year, the same return with 1% more in fees taken out, it grows to about $574,000.
That one percentage point costs about $187,000, roughly a quarter of the final balance.
What about ETFs?
An ETF (exchange-traded fund) is usually an index fund that trades on a stock exchange like a share. You can buy or sell it at any time during the trading day, rather than at a single price at the close. Its holdings are published daily, and it's often more tax-efficient. The first, SPY, launched in 1993 and still tracks the S&P 500. For a beginner, a low-cost index mutual fund and a low-cost index ETF on the same index do much the same job.
The limits
An index fund owns the whole market, good and bad. In a bubble, it holds overpriced shares at full weight. In a crash, it falls with everything else. Index investing works best for people who can sit through a downturn. Selling in a panic locks in the losses that patience would usually have recovered.
Learn it properly
Finance Brain's Index Funds and ETFs lesson, in the Equities course, covers all of this in more depth. It also explains how funds copy an index with thousands of holdings, and how to judge one by its tracking error. It ends with a short quiz.
Finance Brain is educational content, not financial advice. Past performance doesn't guarantee future returns.