I remember the first time someone told me to “just invest in index funds.” I nodded like I understood, then went home and googled “what is an index fund” because I had absolutely no idea what they were talking about.
The explanations I found were… not great. Lots of jargon about “passive management” and “market capitalization weighted” and other stuff that made my eyes glaze over. So I’m gonna try to explain this the way I wish someone had explained it to me.
The Simplest Possible Explanation
An index fund is a way to buy a tiny piece of a whole bunch of companies at once, instead of trying to pick individual winners.
That’s it. That’s the core concept.
When you buy shares of an index fund, you’re basically saying “I believe the overall market will go up over time, and I don’t want to spend my life trying to figure out which specific companies will do best.”
The SEC’s investor education site has a good technical breakdown if you want the official version, but honestly the above is the key insight.
What “Index” Actually Means
So where does the “index” part come in? An index is basically just a list of companies that someone has decided to group together.
You’ve probably heard of the S&P 500. That’s an index — it’s a list of 500 of the largest publicly traded companies in the US. When people say “the market was up today,” they’re usually talking about how the S&P 500 performed.
There are tons of different indexes. The Dow Jones is 30 big companies. The Nasdaq focuses on tech. There are indexes for small companies, international companies, specific sectors… basically any grouping you can think of.
An index fund just takes one of these indexes and says “we’re going to buy all the companies on this list, in the same proportions.” So an S&P 500 index fund owns pieces of all 500 companies in the S&P 500.
The SEC has a whole investor bulletin specifically about index funds that goes deeper on how they work if you’re curious.
Why This Is Actually Kind of Brilliant
Here’s the thing that took me a while to understand: almost nobody consistently beats the market over long periods of time. Not professional fund managers, not stock pickers, not financial advisors. There’s tons of research on this.
So instead of trying to be smarter than everyone else and pick the “right” stocks, you just… buy everything. You get the market’s average return, which historically has been pretty good (around 10% annually over long periods, though obviously this varies year to year).
And because index funds don’t need a team of analysts trying to find the best stocks, they have really low fees. This matters more than you might think — a 1% fee difference compounds into huge amounts over decades.
When I wrote about starting to invest with basically no money, index funds were the first thing I recommended for exactly these reasons. Low minimum investments, low fees, automatic diversification.
The Most Common Index Funds
If you’re just starting out, these are the ones you’ll hear about most:
Total Stock Market funds: These try to own essentially every publicly traded company in the US. Even broader than the S&P 500.
S&P 500 funds: Just the 500 largest US companies. Very popular, very boring, historically very effective.
Total International funds: Companies from outside the US. Good for diversification since different economies grow at different rates.
Bond index funds: Same concept but with bonds instead of stocks. Usually less volatile but lower returns.
A lot of people just do a simple mix — like 80% total stock market fund, 20% total international — and call it a day. Adjust the bond allocation as you get closer to retirement. That’s it. That’s a whole investment strategy.
The Part That Confused Me for Years
Okay so here’s where I was confused for a long time: what’s the difference between an index fund, an ETF, and a mutual fund?
Short answer: these are different “containers” for the same basic thing.
A mutual fund is the traditional way — you buy shares once a day at the closing price, there’s often a minimum investment (sometimes $1,000 or more).
An ETF (exchange-traded fund) trades like a stock throughout the day, usually has no minimum beyond the cost of one share, and is often more tax-efficient.
Both can be index funds. So you might see “Vanguard Total Stock Market Index Fund” (mutual fund version) and “VTI” (ETF version) — they hold the same stuff, just in different wrappers.
When I started investing in my 20s, I overthought this distinction way too much. Just pick one and start. The wrapper matters way less than actually getting money invested.
What I Actually Do
For what it’s worth, my approach is pretty boring:
I put money into a total stock market index fund and a total international index fund. That’s most of it. I have a small amount in bonds now that I’m getting older. I add money every month automatically and don’t look at it much.
Some months the market goes down and I lose money on paper. Some months it goes up. Over years, it’s trended upward. That’s the whole game plan.
Is this the absolute optimal strategy? Probably not. But it’s good enough, it’s easy to stick with, and I don’t have to stress about picking stocks or timing the market.
If you’re feeling overwhelmed by investing options, just start with a single total stock market index fund. You can get fancy later if you want. But you don’t have to.