Index funds are how most ordinary people — not Wall Street traders, not finance professionals, not people with insider knowledge — build real, lasting wealth. Warren Buffett has publicly recommended them for decades. The data is overwhelmingly on their side. And yet most people still do not own a single one.
This guide covers everything you need to know to start investing in index funds today, even if you have never invested before.
What is an index fund?
An index fund is a type of investment fund that tracks a specific market index — like the S&P 500 (the 500 largest companies in the US), the total stock market, or the international stock market. Instead of a fund manager picking which stocks to buy, the fund automatically holds every stock in the index in proportion to its size.
When you invest in an S&P 500 index fund, you are buying a tiny slice of Apple, Microsoft, Amazon, Google, Berkshire Hathaway, and 496 other major companies in one purchase. If the market goes up, your investment goes up. If specific companies fail, the impact is minimal because you own hundreds of others.
This is the beauty of index funds: instant diversification, low cost, and performance that matches the market rather than trying to beat it.
Why index funds beat most actively managed funds
Active funds are run by professional managers who spend their days researching stocks, trying to identify which ones will outperform the market. They charge you for this expertise — typically 0.5% to 1.5% of your investment per year in fees. The promise is that their skill will deliver returns above what the market does on its own.
The problem: the data shows they almost never deliver. Over any 15-year period, roughly 85% to 90% of actively managed funds underperform their benchmark index. The managers who do beat the market rarely do it consistently year after year.
Index funds, by contrast, charge almost nothing — a good S&P 500 index fund charges as little as 0.03% per year (that is $3 per year on a $10,000 investment). They simply match the market, which turns out to be better than what most professionals achieve after fees.
The math over time: $10,000 invested in an S&P 500 index fund in 1993 would be worth over $220,000 by 2023, assuming dividends were reinvested. The same amount in the average actively managed fund would be worth significantly less — because fees compound just like returns do, but in reverse.
Index funds vs. ETFs — what is the difference?
You will often hear “index funds” and “ETFs” (exchange-traded funds) discussed together because they are very similar. Both can track the same index, both have low fees, and both give you diversification. The main differences are structural:
- Traditional index funds are priced once per day at market close. You buy and sell at the day’s closing price. Most are available through brokerages and retirement accounts like 401(k)s and IRAs.
- ETFs trade throughout the day like individual stocks, so you can buy and sell at any point during market hours. They often have no minimum investment and can be bought for the price of a single share.
For long-term investors, this distinction rarely matters. Pick whichever type is available in your account and has the lowest expense ratio. Many people use ETF versions of index funds because they have no minimum investment requirement.
The best index funds for beginners
You do not need dozens of funds. Most people can build a complete, well-diversified portfolio with just two or three:
Total US stock market funds
These track every publicly traded company in the US — roughly 3,500 to 4,000 companies. They give you exposure to large companies, mid-size companies, and small companies all at once. Good options include Vanguard Total Stock Market Index Fund (VTSAX or VTI), Fidelity Total Market Index Fund (FSKAX or FZROX), and Schwab Total Stock Market Index Fund (SWTSX or SCHB).
S&P 500 index funds
These track the 500 largest US companies. They are slightly less diversified than total market funds (they exclude smaller companies) but cover roughly 80% of the US stock market’s total value. The most popular options are Vanguard’s VOO or VFIAX, Fidelity’s FXAIX, and Schwab’s SWPPX.
International stock market funds
These give you exposure to companies outside the US — Europe, Asia, emerging markets. Adding an international fund gives you global diversification. Vanguard Total International Stock Market (VXUS or VTIAX) is the most commonly recommended.
Bond index funds
Bonds are less volatile than stocks and help balance your portfolio as you get closer to needing the money. Vanguard Total Bond Market (BND or VBTLX) is a standard choice. Younger investors typically hold fewer bonds; the closer you are to retirement, the more bonds you may want.
How to buy index funds step by step
Step 1 — Choose where to invest
You need a brokerage account to buy index funds. For most people, the best starting point is one of these:
- Fidelity: No account minimums, excellent zero-fee index funds, great for beginners.
- Vanguard: The original index fund company, very low fees, but the interface is less beginner-friendly.
- Schwab: No minimums, low-cost index funds, good customer service.
If you have access to a 401(k) through work, start there to get any employer match. Then open a Roth IRA for additional tax-advantaged investing. Once you have maxed those out, open a regular taxable brokerage account.
Step 2 — Open your account
The account opening process takes about 10 to 15 minutes online. You will need your Social Security number, a government-issued ID, and your bank account information to fund the account. Most brokerages have a $0 minimum to open an account.
Step 3 — Fund the account
Transfer money from your bank account to your new brokerage account. The transfer typically takes 1 to 3 business days to complete. You can start with as little as $1 if you are buying ETF shares — or whatever the minimum investment is for the mutual fund version you want.
Step 4 — Search for your fund and buy
Search for the ticker symbol of the fund you want (like VTI or FXAIX). Review the fund details — the expense ratio, the index it tracks, and the minimum investment. Place your order. For mutual funds, you typically buy in dollar amounts. For ETFs, you buy in shares (and can buy fractional shares on most platforms).
Step 5 — Set up automatic investing
This is where most new investors go wrong — they invest once and then stop. Set up automatic monthly contributions so money moves from your bank account to your investments on a set schedule. This is called dollar-cost averaging, and it is one of the most powerful habits you can build as an investor. You buy more shares when prices are low and fewer when prices are high, which averages out to better results over time.
What to do when the market drops
Markets go down. Sometimes significantly. In 2008, the S&P 500 dropped about 57%. In early 2020, it dropped 34% in about a month. In 2022, it was down about 20%. Every one of these drops was followed by a recovery and new all-time highs.
The worst thing you can do when the market drops is sell your index funds. This locks in your losses and means you miss the recovery. The correct response is to do nothing — or better yet, to keep investing and buy more shares at lower prices.
Time in the market beats timing the market, every time. The investors who came out ahead through 2008, 2020, and 2022 were the ones who stayed invested and kept contributing.
How much should you invest?
There is no minimum that makes investing worthwhile. Even $50 a month invested consistently over decades grows into a substantial amount thanks to compound interest. The earlier you start, the better — but the second best time to start is right now, with whatever you can spare.
As a general framework:
- Contribute enough to your 401(k) to get the full employer match (that is a 50% to 100% instant return on your money)
- Max out a Roth IRA if eligible ($7,000 per year in 2024 or 2025)
- Go back to your 401(k) and contribute more
- Then use a taxable brokerage account for anything beyond that
Frequently asked questions
Can I lose all my money in an index fund?
Technically possible but practically impossible for a broad market index fund. For an S&P 500 index fund to go to zero, every single major US company — Apple, Microsoft, JPMorgan Chase, Johnson & Johnson, and 496 others — would have to go bankrupt simultaneously. If that ever happened, money itself would be worthless and no investment would be safe. A diversified index fund is one of the safest long-term investments available.
How long should I hold an index fund?
The longer, the better. Index funds are long-term investments. Over any 20-year period in US history, the S&P 500 has been positive. Shorter periods can see losses. If you need the money within 5 years, it should not be in the stock market. If you are investing for retirement decades away, time is your most valuable asset.
Do index funds pay dividends?
Yes. Many companies in index funds pay dividends, which get passed on to you as a shareholder. In most investment accounts, you can set dividends to automatically reinvest — buying more shares, which accelerates your growth through compounding.
What is an expense ratio and why does it matter?
The expense ratio is the annual fee you pay to own a fund, expressed as a percentage. A 0.03% expense ratio means you pay $3 per year for every $10,000 invested. A 1% expense ratio means $100 per year. Over 30 years, that difference in fees can cost you tens of thousands of dollars. Always look for funds with expense ratios below 0.10% for index funds — anything above 0.20% is too high for a passive fund.
Should I invest in one fund or multiple?
One good total market fund is genuinely all you need. But two or three funds — US market, international market, and bonds — gives you a well-rounded portfolio. Do not over-complicate it. A simple, low-cost portfolio you stick with beats a complicated one you abandon during a market downturn.
Index funds are not exciting. That is the point. You are not trying to find the next hot stock or time the market. You are building wealth steadily, consistently, over time — which is exactly what makes it work.