A fund is a collection of securities or other instruments in an investment basket -to put it simply: a portfolio of individual stocks or bonds, or a mix of the two.
An index fund is either a mutual fund, or an ETF, with an asset allocation aiming to match or track a real financial index, like the Dow Jones Industrial Average, Nasdaq Composite, or Standard & Poor's (top) 500 index (called S&P 500 index fund, or SP500 for short).
Of course, index funds are not restricted to follow the most popular indexes out there. They are designed to track any fund or specified basket of securities.
What are index funds?
Mutual funds vs. ETFs
Mutual funds - what are they?
When someone invests in a mutual fund, they (with other investors) create a pool of capital, which is then used and invested into a set portfolio, managed by fund managers. These funds have plenty of shapes and sizes - they might resemble an index, or might be built towards a different investment goal, like ESG.
ETFs - how different are they from mutual funds?
ETFs - or exchange-traded funds - works a bit differently. In such a situation, the underlying assets within an ETF are owned by someone else. This "someone" (another fund manager) creates a fund that tracks the owned underlying securities. Then, investors can invest in a said fund for different expense ratios, but they do not own the securities themselves, they are just gaining or losing on price movements.
Summing up Index Funds
From a different aspect, it can be viewed as a tool of measurement - hence the name benchmark index - to measure the performance of a market, an industry, or any group of instruments and assets. Because of its capability to cover a broad range of assets, it is considered a popular and cheap alternative instead of actively creating and managing portfolio security by security.
What are index funds?
Index funds: are they passively or actively managed funds?
Index funds are passively managed funds. What does this mean?
There are two schools of fund management - passively, and actively managed mutual funds. Let's take a look at how these index funds work and what their differences are.
What does an actively managed fund mean?
An actively managed fund has a dedicated portfolio manager (or managers); investment professionals who pick securities for the fund's portfolio to meet the fund' investment goals. Also, when it comes to active investing their goal is to outperform a benchmark index or a particular market index.
What does a passively managed fund mean?
A passively managed fund is basically the opposite of an actively managed fund. When it comes to passive investments, here, no flesh-and-blood investment managers take part in the process. Securities in the fund are automatically added or removed to match a specific index's behaviour.
What asset type suits passive investing more: mutual funds or ETFs?
If you like the idea of going passive, the next step is to choose what financial product would fit you best. To answer this question, Ben Reynolds from Sure Dividend gives a great explanation.
"True passive investing does not involve active trading. Traditionally, ETFs tend to have a more passive investment style – like following a broad market ETF whereas mutual funds may be more involved in selecting individual securities for the fund in the hopes of outperforming.
Because of the above distinction, ETFs are likely to better suit investors looking for a truly passive investing approach. With that said, there is significant variation within mutual funds and ETFs, so it does come down to the individual funds and ETFs in question."
-Ben Reynolds, Sure Dividend
Derek Sall from Life and my Finances also shared his take on this question above.
"Index funds are super cheap because there's no need for constant management. They're still quite diversified, so (as we said before) they'll likely go up in value over time. With mutual funds, you're probably looking to beat the market in a particular business sector. You could win big, but you could also lose big as well. If you're more of a "steady Eddie", then index funds are probably your game.
For me, I like to stash most of my cash in index funds. Beyond this, I invest in real estate and business ventures for greater returns."
-Derek Sall, Life and my Finances
What are index funds?
Where to look for more?
Hope you liked this quick rundown on index funds. If you'd like to see more, navigate to one of the articles below: