What is an index fund?

Question

What is an index fund?

Answer 1

It's a mutual fund that attempts to track the movement of a specific stock index, such as the DOW Jones index.  It does this by investing your money in all of the stocks in the index of interest.  If you look at charts of index funds versus the index that they are attempting to track you will see that they are virtually identical.  This means that, for example, if the DOW goes up your corresponding mutual fund goes up and, of course, vice versa.

Answer 2

Normally you buy a stock.  If it goes up , you make money.  With an index fund, a group of buyers gets together and buys every stock within a certain group of stocks (the index).   It spreads the risk.   If one stock goes down, it doesn't matter because 20 might go up.  

It's more risky but way more fun to just pick your stocks and see if you make money.

Answer 3

A follow-up to Paul's answer (which is a good answer btw) is that index funds usually have lower MER's (Management Expense Ratio's) than other mutual funds.  Also index funds usually have better returns than other actively managed mutual funds.

The MER is the total percentage of funds assets that is used for administration, expenses, etc by the mutual fund company.  A high MER can negatively affect your returns.    So index funds have an advantage in that they are a low-cost method of investing.

Also if do research on John Bogle, or Warren Buffet, they both speak very high of index funds.  They deliver better returns than most actively managed mutual funds.