Learn the stock market › Funds, ETFs and bonds › Lesson 2 of 7
What is an index fund?
The index, the dividends and the fund
An index is a number that shows how a group of stocks has done. You cannot buy it. An index fund buys the stocks in it instead, so that it follows the number. Here is $1,000 in the S&P 500 from Jan 4, 1988 to today, about 39 years.
| What | Per year | $1,000 became |
|---|---|---|
| The index, price only | 9.0% | $28,823 |
| The index with dividends | 11.3% | $64,673 |
| An index fund charging 0.2% | 11.1% | $59,834 |
The S&P 500 you see quoted counts only prices. A fund also receives the companies' dividends and buys more with them, so it has done far better than the price index. Its fee is what keeps it a little below the index with dividends. How much dividends have meant for the market as a whole is in the study of the stock market's average return.
Why follow an index?
Nobody has to choose. The fund owns what the index owns. No manager tries to guess which companies will do best.
Low cost. Following a list costs less than researching companies, so index funds often charge little. The SEC points out that not all of them do, so the fee is still worth reading.
You get the market. Before fees, an index fund never beats its index, and it falls just as far when the index falls. Crashes hit in full, as the study of every crash shows.
Not exactly the index
A fund can lag by a little more than its fee: it trades when the index changes, holds some cash and pays for its trades. The SEC calls this tracking error. Some funds also hold only a sample of the index's stocks rather than all of them.
An index fund can be a mutual fund, bought at the day's NAV, or an exchange-traded fund, bought like a stock. That difference is in the lesson on ETFs.
Test yourself
An index rose 8% one year, or 10% with dividends. An index fund on it charges 0.2%. Roughly how much did the fund return?
Source
- US Securities and Exchange Commission, Investor Bulletin: Index Funds, read on 5 November 2026.