Index Funds

An index fund is a mutual fund or exchange-traded fund that holds the same securities as a specific market index, in the same proportions, with the goal of matching the index's performance rather than beating it. Because an index fund simply replicates an index rather than hiring analysts to pick stocks, its costs are dramatically lower than actively managed funds. As of 2025, BlackRock managed $14 trillion in total assets, with roughly $7.8 trillion in equity holdings the majority of which are index-tracking strategies. Vanguard managed approximately $12 trillion, making index-focused passive investing the dominant force in global asset management.

Think of an index fund as buying a slice of the entire market rather than betting on individual stocks: you own everything in the index and go wherever the market goes.

How Index Funds Work

An index fund's manager does not make investment decisions. The fund holds every security in its target index, weighted by market capitalization or another specified methodology. When a stock is added to the S&P 500, every S&P 500 index fund automatically adds it. When a stock is removed, every fund sells it. The fund manager's job is execution and tracking accuracy, not stock selection.

This design keeps costs minimal. Actively managed funds charge an average expense ratio of 0.50% to 1.00% or more annually. The Vanguard S&P 500 ETF charges 0.03%. Fidelity's zero-expense-ratio index funds charge nothing at all for the fund management fee itself. Over a 30-year investment horizon, that cost difference compounds into a substantial performance advantage for the index fund, even before accounting for the fact that most active managers underperform their benchmark over long periods.

The Most Common Index Benchmarks

Index funds track a wide range of benchmarks across asset classes. The most widely used include:

• S&P 500: The 500 largest U.S. publicly traded companies by market capitalization, widely used as the benchmark for U.S. large-cap equity performance
• Total Stock Market: All publicly traded U.S. companies across large, mid, and small-cap, providing broader domestic exposure than the S&P 500
• MSCI World / MSCI ACWI: Global equity benchmarks covering developed markets and, in the case of ACWI, emerging markets as well
• Bloomberg U.S. Aggregate Bond Index: Investment-grade U.S. bonds including Treasuries, agency bonds, and corporate bonds, used as the benchmark for broad U.S. fixed income
• Russell 2000: The 2,000 smallest companies in the Russell 3000 index, used as the benchmark for U.S. small-cap equity

ETF vs. Mutual Fund Structure

Index funds are available in two structures with different practical implications. Mutual fund index funds price once per day after the market closes, accept investments directly from investors without a broker, and have no minimum trade size in fractional share versions. Exchange-traded fund index funds trade throughout the day on stock exchanges like individual shares, can be bought and sold in real time, and typically have lower minimum investment requirements.

For most long-term investors, the choice between structures is secondary to cost and index selection. For tax-sensitive investors, ETFs have a structural advantage: they generally distribute fewer capital gains than mutual funds because of how redemptions are handled in-kind rather than for cash.

The Concentration Problem in Cap-Weighted Indexes

Market-capitalization-weighted indexes like the S&P 500 allocate more weight to larger companies. As of 2025, the five largest S&P 500 constituents, including Microsoft, Apple, Nvidia, Amazon, and Alphabet, accounted for approximately 25% to 30% of the entire index weight. An investor who believes they own a diversified cross-section of 500 companies is in reality heavily exposed to a small number of mega-cap technology companies. Equal-weighted or factor-based index alternatives address this concentration but trade higher diversification for higher turnover and slightly higher costs.

Sources

• https://www.britannica.com/money/BlackRock-Inc
• https://www.morningstar.com/funds/how-vanguard-stacks-up-against-its-fund-industry-peers
• https://www.sec.gov/investor/pubs/sec-guide-to-mutual-funds.pdf