Buying one company’s stock is a bet on that one company. Many people prefer to spread their money across a lot of companies at once. Funds make that easy.
What is a fund?
A fund pools money from many people and uses it to buy lots of different investments. When you buy a piece of the fund, you own a small slice of everything in it.
What is an index?
An index is a list that tracks part of the market. For example, the S&P 500 follows 500 large companies in the United States. Other indexes follow other countries, other company sizes, or bonds.
What is an index fund?
An index fund simply tries to copy an index. If the index holds 500 companies, the fund holds those same 500. It does not try to pick winners. It just follows the list.
This is called passive investing. Because nobody is hunting for the next big winner, these funds are usually cheaper to run than funds where experts choose the investments.
What is an ETF?
ETF stands for exchange-traded fund. It is a fund that is bought and sold on a stock exchange, just like a share, during the day. Many ETFs follow an index, so you will often hear “index ETF”.
The difference from a traditional index fund is mostly how you buy it: an ETF trades during the day, while a traditional fund is usually priced once a day. For a beginner, the idea behind them is the same.
Why do people like them?
- Diversification. One purchase gives you a share in many companies.
- Low cost. Many index funds charge small yearly fees.
- Simplicity. You do not need to pick individual companies.
Fees matter more than they look
Every fund charges a yearly fee, shown as a percentage. It sounds small, but it adds up over time.
Here is a simplified example. You invest 10,000 and the investments grow 5% a year before fees, for 20 years:
| Yearly fee | After 20 years |
|---|---|
| 0.2% | about 25,540 |
| 1.5% | about 19,898 |
That is a difference of about 5,642, just from fees. (This is an illustration. Real returns are not steady like this.)
What are the risks?
- The value can fall. If the market falls, an index fund that follows it falls too. Diversification reduces the risk from one company failing, but it does not remove market ups and downs.
- Not all funds are the same. Some follow narrow or unusual themes and can be much riskier. Read what a fund actually holds before buying.
- Past results do not predict the future.
What to take from this
- A fund holds many investments in one package. An index fund copies a list. An ETF is a fund you can trade like a share.
- Check the yearly fee, and check what the fund holds.
- None of this removes risk. It spreads it out.
Next: How to start investing.