An index fund or index tracker is a collective investment scheme (usually a mutual fund or exchange-traded fund) designed to track, or replicate, the movements of a market index, such as the S&P 500. Tracking of an index can be achieved by trying to hold all of the securities in the index, in the same proportions as the index, or by statistically sampling the market and holding "representative" securities.
An index mutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover.
Some index funds use an algorithmic or computer model with little or no human input. This allows the funds to be managed by a much smaller staff than an actively managed fund. Index funds can have expense ratios as low as 0.18%, while actively managed funds can have an expense ratios over 3.0%.
The machines that run index funds cut the costs of investing by 90 percent or more by skipping most of the research and trading typically done by humans, instead owning essentially all the stocks or bonds in a market basket all the time. Index funds are passive funds in that they don’t set prices; they only accept the prices that active investors have already set.
Some indexes that are widely used for index funds are: the Russell 2000 (small companies), the DJ Wilshire 5000 (total stock market), the MSCI EAFE (foreign stocks in Europe, Australasia, Far East) and the Lehman Aggregate Bond Index (total bond market).