By the MFI Editorial Team | Last verified: June 2026
What an Index Fund Actually Is
An index fund is a fund that holds the same securities as a specific market index, in the same proportions. The S&P 500 index, for example, contains approximately 500 large US companies weighted by market capitalization. An S&P 500 index fund holds those same 500 companies in the same proportions. When the index changes (a company is added or removed), the fund adjusts automatically.
The fund manager's job is not to select better stocks than the market — it is to replicate the index as accurately and cheaply as possible. This passive approach requires minimal trading and minimal management, which is why index funds can charge very low fees.
Why Index Funds Outperform Most Active Managers
S&P Dow Jones Indices publishes an annual report called SPIVA (S&P Indices Versus Active) that tracks how actively managed mutual funds perform relative to their benchmark indices. The findings have been consistent across decades of data: the majority of active fund managers underperform their benchmark index over periods of 10–15 years, after fees.
This is not because active managers are unskilled. It is primarily because active management costs more. A typical actively managed mutual fund charges 0.5–1.0% per year in management fees. A comparable index fund charges 0.03–0.10%. The active manager needs to generate 0.5–1.0% per year in excess returns just to break even with the index after fees — before taxes on higher portfolio turnover. That is a consistent hurdle that most managers, most years, do not clear.
The Three-Fund Portfolio
The three-fund portfolio is a widely-used framework for index fund investing, popularized by the Bogleheads investment community. It consists of three funds:
1. US Total Stock Market Index Fund — covers the entire US equity market, from large-cap to small-cap. Examples: Vanguard Total Stock Market ETF (VTI), Fidelity ZERO Total Market Index Fund (FZROX), Schwab Total Stock Market Index Fund (SWTSX).
2. International Stock Market Index Fund — covers developed and emerging market equities outside the US. Examples: Vanguard Total International Stock ETF (VXUS), Fidelity Total International Index Fund (FTIHX).
3. US Bond Market Index Fund — covers US government and corporate bonds. Examples: Vanguard Total Bond Market ETF (BND), Fidelity US Bond Index Fund (FXNAX).
The allocation between these three funds is the primary decision — how much US stocks vs. international vs. bonds. A common framework: subtract your age from 110 to get an approximate stock allocation percentage. A 40-year-old would hold approximately 70% stocks (split between US and international), 30% bonds. This is a starting point, not a rule — your actual risk tolerance and timeline should drive the allocation.
Where to Buy Index Funds
Index funds are available at virtually every major brokerage. Vanguard, Fidelity, and Schwab all offer their own index funds with expense ratios near zero, and allow commission-free trading of their own funds and most ETFs. The practical starting point: open a brokerage account (or IRA for tax-advantaged investing), choose a fund from each of the three categories above, and set up automatic monthly contributions.
Index Funds and Investment Newsletters
A common question from readers who subscribe to investment newsletters: how do index funds and newsletter stock picks coexist in a portfolio? The standard framework is a core-satellite approach — the core of the portfolio (70–80%+) is held in low-cost index funds for reliable market exposure, and a defined satellite allocation (10–20%) is available for higher-conviction active bets, including newsletter recommendations. This structure gives exposure to potential outperformance while limiting the damage if the active picks underperform.
Last verified: June 2026 | Category: Wealth Building Strategies | Market Intelligence Hub