What Is an Index Fund?
Updated July 9, 2026 · SmartRates Editorial Team
⚡ In short
An index fund is a mutual fund or ETF built to track the performance of a specific market index, such as the S&P 500, by holding the same securities in similar proportions rather than having a manager individually select investments. Because they are not actively managed, index funds typically carry lower expense ratios than actively managed funds.
📌 Key facts
- Index funds can be structured as either mutual funds or ETFs
- Common benchmarks include the S&P 500, the Nasdaq-100, and total-market indexes
- Index funds are described as 'passively managed' — holdings are determined by the index's rules, not by a manager's individual selections
- Expense ratios on broad index funds are commonly a fraction of a percent annually, disclosed in the fund prospectus
🏛️ Official sources
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How an index fund tracks its benchmark
An index fund holds the same securities as its target index, in proportions designed to mirror that index, so that the fund's performance closely follows the index's performance before fees. When the index provider changes the index's composition, the fund adjusts its holdings to match.
Passive vs. active management
Index funds are passively managed, meaning fund holdings are determined mechanically by the rules of the underlying index rather than by a portfolio manager selecting individual securities. Actively managed funds employ a manager or team that selects and adjusts holdings with the aim of outperforming a benchmark.
Expense ratios and tracking error
The expense ratio is the fund's annual operating cost, expressed as a percentage of assets and disclosed in the fund's prospectus. Because index funds require less active research and trading than actively managed funds, they typically carry lower expense ratios. Tracking error refers to the difference between the fund's actual return and the underlying index's return, which can result from fees, trading costs, and timing differences.
Index funds structured as ETFs vs. mutual funds
The same index can be tracked by either an ETF or a mutual fund. An index fund structured as an ETF trades throughout the day on an exchange; an index fund structured as a mutual fund is priced once per day after markets close. Some fund providers offer both an ETF and a mutual fund version of the same underlying index, which can differ in minimum investment, expense ratio, and tax treatment within a taxable account despite tracking the identical benchmark.
Types of index funds by scope
Index funds exist for a wide range of scopes beyond a single broad benchmark like the S&P 500 — sector-specific index funds track a single industry, bond index funds track a basket of fixed-income securities, and international index funds track markets outside the United States. Each fund's specific index and methodology are described in its prospectus, so two funds referencing similar-sounding benchmarks can hold meaningfully different securities.
Index reconstitution and rebalancing
Market indexes are periodically reconstituted — companies are added or removed based on the index's published rules, such as market capitalization thresholds — and index funds adjust their holdings to match these changes when they occur. This process is distinct from a fund manager making discretionary investment decisions, since the fund is simply following the index provider's predetermined rules rather than exercising independent judgment about which securities to hold.
How index funds are weighted
Most broad market index funds use market-capitalization weighting, meaning larger companies (by total market value) make up a proportionally larger share of the fund than smaller companies within the same index. Some index funds instead use equal weighting or other alternative weighting schemes, which produce a different mix of holdings even when tracking a similarly named index, since the weighting methodology directly determines how much of the fund is allocated to each constituent security.
Where index fund performance data is published
A fund's historical performance, expense ratio, and holdings are disclosed in its prospectus and annual or semi-annual shareholder reports, filed with the SEC and made available by the fund provider. This same disclosure framework applies to actively managed funds, allowing performance and cost to be compared across both fund types using standardized, regulator-mandated reporting.
Historical performance disclosure requirements
SEC rules require fund marketing materials that show historical performance to include a standardized disclaimer stating that past performance does not guarantee future results, since an index or fund's prior returns are historical data rather than a predictor of what the fund will return going forward. This disclosure requirement applies uniformly to index funds and actively managed funds alike.
Index funds within employer retirement plans
Many employer 401(k) plans include one or more index funds among the plan's investment menu options, often as a target-date fund's underlying component or as a standalone selection, since index funds' typically lower expense ratios are a factor plan administrators consider under their fiduciary duty when selecting the plan's fund lineup. The specific index funds available differ by plan, since each employer's plan administrator selects its own menu of options.
Frequently Asked Questions
Does an index fund guarantee the index's exact return?+
No. Fees and tracking error mean the fund's actual return can differ slightly from the index's stated return, though the difference is typically small for broad, low-cost index funds.
Are all ETFs index funds?+
No. While many ETFs are index funds, some ETFs are actively managed and do not track a specific benchmark index.
Who determines what's in a market index like the S&P 500?+
Each index has a provider — for example, S&P Dow Jones Indices for the S&P 500 — that sets and periodically updates the rules for which securities are included.
Can the same index be tracked by more than one fund?+
Yes. Multiple fund providers can each offer their own fund tracking the same published index, and these competing funds can differ in expense ratio and structure despite tracking the identical benchmark.
What happens to an index fund's holdings when the index changes?+
The fund adjusts its holdings to match the index's updated composition whenever the index provider reconstitutes it, following the index's predetermined rules rather than a manager's discretionary decision.
Do index funds ever hold cash instead of being fully invested?+
Most index funds aim to stay nearly fully invested to minimize tracking error, though a small cash position is sometimes held to manage day-to-day shareholder purchases and redemptions.