Table of Contents
What is an index fund?
How do index funds work?
Key things to know about index funds
Examples of index funds
Index funds vs. actively managed funds
Other things to consider
The bottom line
Jun 21, 2022
7 min read
An index fund is a way to invest in every stock within a particular index or grouping, and their goal is usually to try to match the performance of a benchmark market index.
Investing in index funds has become increasingly popular in recent years. Investment research firm Morningstar reported in August 2021 that US stock index funds held $884 billion more in assets than active funds—and they continue to gain market share. Investing in index funds is a hands-off and passive approach that investors use to try and match, rather than beat, the market. Markets tend to rise over time, and index funds seek to capture those gains while holding down fees that tend to eat into returns.
“An index fund is a way to invest in every stock within a particular index or grouping,” explains John DeYonker, head of investor relations at Titan. These funds are either mutual funds or exchange-traded funds (ETFs), and their goal is usually to try to match the performance of a benchmark market index. In turn, a market index tracks a certain group of assets, such as stocks or bonds.
For example, the S&P 500 stock market index tracks 500 of the largest publicly traded US companies from leading industries. “You can't technically invest in the S&P 500,” DeYonker says. “That’s why you would need to invest in an index fund.” An S&P 500 index fund tries to mirror the S&P 500 index’s movement.
How an index fund works depends on who creates and manages the fund, and whether it’s a mutual fund or ETF. But the basics are often similar.
The fund pools money from investors, and the fund manager uses the money to try and replicate the benchmark index. There are funds for all sorts of market indexes, including stock (i.e., equity) indexes and bond indexes.
Index funds use a passive investment approach, meaning they simply try to mirror the changes in the chosen benchmark. Assets may be invested in the stocks and bonds that the benchmark tracks—or in a representative sample—and fund managers may buy and sell securities to try and move in tandem with the index.
Many, but not all, index funds have lower fees than actively managed funds.
Index funds aren’t always able to match their benchmark. When there’s a discrepancy between an index fund and its benchmark index, that’s called a tracking error.
By choosing an index fund that mirrors a large stock market index, investors can easily invest in a stock market’s overall performance.
While index fund investing is a popular hands-off approach, it isn’t without risk because it mirrors both the rising and falling price of its benchmarks.
For retail investors, using index funds may be an easier option than trying to buy and sell individual stocks or bonds.
Fund companies can create index funds to track a variety of benchmarks. These include broad stock market indexes, bond indexes, and indexes that focus on a specific region, industry, or other criteria.
These examples are just a small sample of the many types of index funds available to investors:
A mutual fund that tries to track stock market returns from around the world using the FTSE Global All Cap Index as a benchmark.
A mutual fund that tries to track the total return of the S&P 500 index.
An ETF that tries to track the S&P High Yield Dividend Aristocrats Index, which looks for companies that consistently increase their dividends over time.
A mutual fund based on the MSCI USA ESG Index, which tracks mid- and large-cap companies that rate well on environmental, social, and governance (ESG) metrics.
A municipal bond ETF that focuses on California municipal bonds that are exempt from the alternative minimum tax, or AMT. It tries to track the ICE BofAML California Long-Term Core Plus Municipal Securities Index.
Instead of index funds, some investors put their money into actively managed funds and ETFs. While index funds take a passive approach to investing by trying to mirror a benchmark, actively managed funds attempt to beat it.
An actively managed fund will often choose a market index as its benchmark. Then, based on research and analysis, fund managers look for investment opportunities either by finding undervalued shares or by timing the buying and selling of securities to beat their benchmark.
If fund managers outperform their benchmark, they’re “creating alpha” (expressed in return calculations as α), a term that describes how well an investment strategy performs relative to its benchmark.
Beyond the approach and goal, there are a few things investors consider when comparing index funds to actively managed funds:
Fees can reduce the rate of return on an investment. When comparing investment options, investors may want to look at passive and actively managed funds’ total returns after fees.
Index funds tend to have lower expense ratios than actively managed funds. The expense ratios are shown as percentages and taken out of a fund’s assets by the fund manager.
According to the Investment Company Institute (ICI), an international association for regulated funds, the average expense ratio for index equity mutual funds was 0.06% in 2020. It was 0.71% for actively managed equity mutual funds.
The ICI found that index equity ETFs had a higher average expense ratio of 0.18% and index bond ETFs had an expense ratio of 0.13%. It didn’t report an average expense ratio for actively managed ETFs, but the vast majority of ETFs are passive index funds.
The actively managed funds’ higher fees are used to pay for the expertise and analysis that’s needed to continually research and act on investment ideas. Sometimes there are additional fees, such as account management and mutual fund load fees.
While fees can eat into returns, performance is also important. When comparing investment options, investors may want to look at passive and actively managed funds’ total returns after fees. While actively managed funds often have higher expense ratios, their overall performance may best passively managed funds—particularly for certain types of assets and over shorter timelines.
For example, during the year ended June 30, 2021, actively managed funds outperformed their benchmarks 41.8% of the time, according to S&P Dow Jones indices’s SPIVA research. And actively managed California municipal debt funds consistently outperformed their benchmark over one-, three-, five-, and 10-year periods.
But over a 10-year period ending on the same date, only 17.49% of actively managed large-cap funds outperformed the S&P 500.
Investors who have taxable brokerage accounts may also want to consider the tax implications of index versus actively managed funds. Actively managed funds tend to produce more taxable gains than passive funds because the fund managers trade more often.
Index mutual funds and ETFs give investors a way to invest in different indexes. Investors can look for funds that track international markets, domestic indexes, specific sectors, or meet other criteria. The passive approach usually comes with lower fees, but it isn’t meant to outperform markets.
Actively managed funds often charge higher fees, but they also try to use their expertise to beat the market. Some actively managed funds are able to do this, and by doing so, increase the overall returns that their investors earn.
At Titan, we are value investors: we aim to manage our portfolios with a steady focus on fundamentals and an eye on massive long-term growth potential. Investing with Titan is easy, transparent, and effective.
Get started today.
Certain information contained in here has been obtained from third-party sources. While taken from sources believed to be reliable, Titan has not independently verified such information and makes no representations about the accuracy of the information or its appropriateness for a given situation. In addition, this content may include third-party advertisements; Titan has not reviewed such advertisements and does not endorse any advertising content contained therein.
This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Furthermore, this content is not directed at nor intended for use by any investors or prospective investors, and may not under any circumstances be relied upon when making a decision to invest in any strategy managed by Titan. Any investments referred to, or described are not representative of all investments in strategies managed by Titan, and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results.
Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Please see Titan’s Legal Page for additional important information.
You might also like
Index Fund vs. ETF: What's the Difference?
Index funds and ETFs while traded differently, can both offer a low-cost way to invest in a diversified group of assets.
How to Invest in Index Funds: A Beginner’s Guide
An index fund is a type of fund that tries to mirror the performance of a benchmark market index, such as the S&P 500 stock market index. Investors can use a brokerage or retirement account to purchase exchange-traded funds (ETFs) or mutual funds that track indexes.
Index Fund vs. Mutual Fund: What’s the Difference?
Some mutual funds are also index funds, but more often, mutual fund managers actively manage the fund to try to outperform an index.
© Copyright 2024 Titan Global Capital Management USA LLC. All Rights Reserved.
Please refer to Titan's Program Brochure for important additional information. Certain investments are not suitable for all investors. Before investing, you should consider your investment objectives and any fees charged by Titan. The rate of return on investments can vary widely over time, especially for long term investments. Investment losses are possible, including the potential loss of all amounts invested, including principal. Brokerage services are provided to Titan Clients by Titan Global Technologies LLC and Apex Clearing Corporation, both registered broker-dealers and members of FINRA/SIPC. For more information, visit our disclosures page. You may check the background of these firms by visiting FINRA's BrokerCheck.
Various Registered Investment Company products (“Third Party Funds”) offered by third party fund families and investment companies are made available on the platform. Some of these Third Party Funds are offered through Titan Global Technologies LLC. Other Third Party Funds are offered to advisory clients by Titan. Before investing in such Third Party Funds you should consult the specific supplemental information available for each product. Please refer to Titan's Program Brochure for important additional information. Certain Third Party Funds that are available on Titan’s platform are interval funds. Investments in interval funds are highly speculative and subject to a lack of liquidity that is generally available in other types of investments. Actual investment return and principal value is likely to fluctuate and may depreciate in value when redeemed. Liquidity and distributions are not guaranteed, and are subject to availability at the discretion of the Third Party Fund.
The cash sweep program is made available in coordination with Apex Clearing Corporation through Titan Global Technologies LLC. Please visit www.titan.com/legal for applicable terms and conditions and important disclosures.
Cryptocurrency advisory services are provided by Titan.
Information provided by Titan Support is for informational and general educational purposes only and is not investment or financial advice.
Contact Titan at firstname.lastname@example.org. 508 LaGuardia Place NY, NY 10012.