How Does an Index Fund Work?

If you're preparing to enter the often perilous investment expressway, you don't want to become just another deer that gets caught in the headlights. To avoid becoming investment roadkill, you may want to consider a relatively safe, but not necessarily conservative, financial vehicle in which to place your hard-earned dough. One possibility is a type of mutual fund known as an index fund.

What's a Mutual Fund?

A mutual fund is an investment vehicle that pools money from a large number of investors. The individual who manages the fund, cleverly titled the fund manager, places the money in a series of investments like stocks, bonds or money market accounts. Spreading your money among a number of investments instead of just one can help to minimize the risk, which may make mutual funds more appealing than purchasing individual stocks.

What Does "Index" Mean?

An index is so much more than the finger next to your thumb or the last section of a book. When it comes to investing, an index is a group of similar stocks or bonds that represent a particular segment of the market. The similarities make returns more predictable and stable over time. A commonly known index is the Standard and Poor's (S&P) 500, a grouping of 500 large-company stocks with similar characteristics.

Index Funds in Action

An index fund is a mutual fund that invests in stocks that are typically included in the S&P 500 or other index. While index funds do have a fund manager, this person's job is much easier than that of a fund manager who handles a more volatile investment portfolio. Their job is simply to attempt to invest your money into stocks or bonds within the chosen index, with the ultimate goal of matching the index's performance over time.


If you're interested in a relatively safe, predictable return on your money over the long haul, index funds may be a good investment choice for you. You'll have less chance of losing your shirt, index finger or any other valued property than you would if you invested in individual stocks, although your returns may also be smaller. Because they require less management, index funds typically incur lower expenses, meaning more of your investment dollar goes to the actual investment.

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