What Is an
Index Fund?

An index fund is a pool of money from many investors that buys all the stocks in a specific market index — like the S&P 500 (largest 500 US companies), the FTSE 100 (largest 100 UK companies), the ASX 200 (largest 200 Australian companies), or the TSX 60 (largest 60 Canadian companies). Instead of paying a fund manager to pick winners, the fund just copies the index, holds the same stocks in the same proportions, and charges a tiny fee for doing so. You get the average return of the index (minus the fee), which historically has beaten 90%+ of actively managed funds over 20-year periods.

Two ways. (1) Price appreciation — the stocks inside the fund go up over time, so your share of the fund goes up too. (2) Dividends — the companies inside the fund pay dividends to shareholders, which the fund either pays out to you in cash or automatically reinvests. The S&P 500 has averaged about 10% total annual return (price + dividends) over the last 30 years, with significant variation year to year (the worst calendar year in that window was 2008 at -37%; the best was 2013 at +32%). Long-term, the compounding is what matters.

An index fund is the strategy — passively tracking an index. An ETF (exchange-traded fund) is one of two wrappers that strategy can come in; the other is a traditional mutual fund. ETFs trade on a stock exchange like individual stocks (you buy/sell at intraday prices), are usually slightly more tax-efficient in taxable accounts (especially in the US), and tend to have slightly lower expense ratios. Mutual fund index funds settle once a day at the end-of-day NAV (net asset value), but offer fractional-share purchases and automatic-contribution programs that ETFs sometimes don't. Vanguard VTSAX (mutual fund) and VTI (ETF) hold essentially the same underlying portfolio — total US market — with marginally different mechanics.

The expense ratio is the annual fee the fund charges, expressed as a percentage of your invested balance. A 0.03% expense ratio means $3 per year on a $10,000 balance. The cheapest index funds today charge 0.03-0.10% per year (Vanguard VTI, Fidelity FZROX, iShares ITOT, Schwab SWTSX in the US; Vanguard VAS or Betashares A200 in Australia; Vanguard VFV or XEQT in Canada). Actively managed funds typically charge 0.50-1.50% per year. Over 30 years, the difference between a 0.03% index fund and a 1% active fund can cost you 25-30% of your final balance to fees alone. This is the single biggest reason index funds beat active funds over long periods.

Index funds are not risk-free — they own stocks, and stocks fluctuate. In 2008 the S&P 500 dropped 37%; in March 2020 it dropped 34% in five weeks. But they are diversified — owning the entire market means no single company can ruin you. The risks are market-wide drawdowns (which historically recover within a few years) and inflation (which erodes purchasing power even when your nominal balance grows). The standard advice — invest only money you don't need for 5-10 years, diversify globally, and don't sell during drawdowns — applies in full to index funds. They are NOT insured by the FDIC / FSCS / equivalent because they aren't bank deposits.

The orthodox answer for most working-age investors: as much of your long-term savings as you can afford after covering an emergency fund and high-interest debt. The Bogleheads three-fund portfolio (US total stock + international stock + total bond) is a common starting point. Asset allocation depends on age, risk tolerance, and tax-advantaged-account limits (401(k), Roth IRA, HSA in the US; super in Australia; RRSP and TFSA in Canada; ISA and SIPP in the UK). Use Richify's compound interest calculator to project what regular monthly contributions to an index fund grow to over 10/20/30 years at the historical S&P 500 average return.

This is personal but the most common picks: For US investors — Vanguard VTI (total US market, 0.03% ER) or VOO (S&P 500, 0.03% ER) for stocks; VXUS (total international ex-US, 0.07% ER) for diversification. For Australian investors — Vanguard VAS (ASX 300, 0.07% ER), Vanguard VGS (developed-markets ex-Australia, 0.18%), or Vanguard VDHG (all-in-one diversified, 0.27%). For Canadian investors — Vanguard VFV (S&P 500 in CAD, 0.09%) or XEQT (all-equity ETF, 0.20%). For UK investors — Vanguard VWRL (FTSE all-world, 0.22%) or HSBC HMWO. Richify doesn't sell or recommend specific funds — these are widely-cited examples by independent finance writers. Check the expense ratio, the index tracked, and the tax-efficiency in your account type before buying.

The fund itself is highly liquid, but the account holding it may not be, and those are two different questions people often merge. On liquidity: an index ETF trades on an exchange throughout the day and you can sell at any point the market is open, with cash settling shortly afterwards (T+1 in the US and Canada since 2024). A mutual-fund index fund does not trade intraday — your order executes once at the end-of-day NAV, so you know the price only after the close. Either way the money is available in days, which is far more liquid than property. The real constraint is usually the wrapper, not the fund: money inside a US 401(k) or IRA, Australian super, a Canadian RRSP or a UK SIPP is subject to age and withdrawal rules regardless of how liquid the underlying fund is, and taking it out early can trigger tax or penalties. A taxable brokerage account, a UK Stocks & Shares ISA or a Canadian TFSA has no such lock. One caveat on liquidity itself: a fund is only as liquid as what it holds, so broad large-cap index funds are the most liquid, while funds tracking small-cap, emerging-market or niche sector indices can see wider spreads in stressed markets.

Four real ones, and they are the flip side of the same design. (1) You get the market return and never beat it — by construction an index fund cannot outperform its index, so if you want a shot at above-market returns this is the wrong instrument. (2) You own the whole index, including companies you think are overvalued or object to; there is no filtering. (3) Diversification does not mean protection. A market-cap-weighted index puts the most money into whatever is already the largest, so a handful of the biggest companies can drive a large share of the S&P 500's movement — 'diversified' describes the number of holdings, not the concentration of the risk. (4) Index funds fall with the market and offer no downside cushion: the S&P 500 fell 37% in 2008 and 34% in five weeks in early 2020. That matters most in the years just before and after retirement, when a large drawdown hits a portfolio you have started drawing from — the sequence-of-returns problem. None of these are arguments against index funds for long-horizon investors; they are the reason the standard advice pairs them with a time horizon of 5-10 years or more.

Three structural reasons backed by SPIVA (S&P Indices vs Active) data and Morningstar's Active/Passive Barometer. (1) Fees compound — an active fund charging 1% per year has to outperform the index by 1% per year just to break even with you, which is mathematically a high bar. (2) Survivorship bias — the active funds that underperform get shut down, so the average performance of surviving active funds looks better than reality. (3) The market is dominated by professional traders — when one beats the index, another must lose to them; collectively, active managers ARE the market (minus fees). Over 20 years, ~85-95% of active US large-cap funds underperform the S&P 500 net of fees, depending on the SPIVA report year.