What Is an Index Fund and Why Do Experts Love Them?

Warren Buffett has given a lot of investing advice over the years. One piece stands above the rest: for most investors, a simple S&P 500 index fund is the best investment available. Not a hedge fund. Not an actively managed mutual fund. Not individual stock picking. A plain index fund.

That's a bold claim from the world's most famous investor. Here's why he's right — and how index funds actually work.

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What Is an Index Fund?

An index fund is a type of investment fund that tracks a market index — a predefined list of stocks or bonds. Instead of a fund manager picking and choosing which stocks to buy, the fund simply owns every stock in the index in proportion to its size.

The most famous index is the S&P 500 — a list of the 500 largest publicly traded U.S. companies, weighted by market capitalization. An S&P 500 index fund owns all 500 companies, from Apple and Microsoft down to smaller names at the bottom of the list.

When you buy shares of an S&P 500 index fund, you're instantly diversified across 500 companies in a single purchase. If one company collapses, it barely moves your portfolio. If the overall U.S. economy grows — as it historically has over long periods — your investment grows with it.

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Why Index Funds Beat Most Active Managers

This is where the data gets uncomfortable for the fund management industry. According to SPIVA (S&P Dow Jones Indices vs. Active) scorecards, which compare actively managed funds to their benchmark indexes:

• Over 10 years, roughly 85–90% of actively managed large-cap U.S. funds underperform the S&P 500
• Over 20 years, the underperformance rate is even higher — often above 90%

Why can't professional fund managers consistently beat the market? A few reasons:

Fees eat returns. Actively managed funds typically charge 0.5–1.5% annually in expense ratios. Index funds often charge 0.03–0.10%. Over 30 years, a 1% fee difference can cost you tens of thousands of dollars on a modest portfolio.

Markets are hard to beat. Millions of professional investors, algorithms, and institutions are all competing for an edge. The collective wisdom of the market is already priced into stock prices. Consistently finding undervalued stocks is genuinely difficult.

Turnover creates taxes. Active funds buy and sell frequently, generating capital gains that you owe taxes on. Index funds rarely sell, keeping your tax bill low.

The conclusion is simple: lower costs + no underperformance = index funds win over time.

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The Most Popular S&P 500 Index Funds

You don't need to research obscure funds. The most popular S&P 500 index funds are household names among investors:

VOO (Vanguard S&P 500 ETF): Expense ratio 0.03%. Tracks the S&P 500 exactly. One of the most widely held ETFs in the world. Minimum: 1 share (typically $500–$550).

SPY (SPDR S&P 500 ETF Trust): The original S&P 500 ETF, launched in 1993. Expense ratio 0.09%. Extremely liquid — the most traded ETF by volume. Functionally identical to VOO.

FXAIX (Fidelity 500 Index Fund): A mutual fund version with an expense ratio of 0.015% — one of the lowest available. No minimums if bought at Fidelity. Great for beginners who want to invest odd dollar amounts.

IVV (iShares Core S&P 500 ETF): Expense ratio 0.03%. BlackRock's S&P 500 fund — virtually identical to VOO in performance and cost.

Any of these is a reasonable long-term choice. The differences are marginal. The most important decision is simply owning one.

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Total Market vs. S&P 500 vs. International: How to Think About It

Beyond the S&P 500, there are a few variations worth understanding:

Total U.S. Market Funds (VTI, FSKAX, SWTSX): Instead of just 500 large companies, these track the entire U.S. stock market — about 3,500 to 4,000 companies including small and mid-cap stocks. Historically, performance is similar to the S&P 500 (large companies dominate the weighting), but you get broader diversification.

International Index Funds (VXUS, FSPSX): Track stocks outside the U.S. — Europe, Asia, emerging markets. Adding 20–30% international exposure diversifies you geographically and reduces concentration in any single country's economy. Many long-term investors hold a mix of U.S. and international funds.

Bond Index Funds (BND, FXNAX): Track a broad basket of U.S. bonds. Lower expected returns than stocks, but much less volatility. Generally more relevant as you approach retirement and want to reduce risk.

A simple starting portfolio for a long-term investor: 70–80% total U.S. market or S&P 500, 20–30% international. That's it. No bonds needed until you're within 10–15 years of retirement.

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How to Buy an Index Fund

You need a brokerage account to buy index funds. Here are the three most common ways:

Through your 401(k): Many 401(k) plans include S&P 500 or total market index funds. Look for funds with "index" in the name and an expense ratio below 0.10%. If your plan offers a Vanguard, Fidelity, or Schwab index fund, use it.

In a Roth IRA: Open a Roth IRA at Fidelity, Schwab, or Vanguard. Contribute up to $7,000 in 2024, then buy index fund shares directly. This is arguably the best first investment account for younger earners.

In a taxable brokerage account: After maxing out tax-advantaged accounts, open a regular brokerage account and invest in the same index funds. You'll owe taxes on dividends and gains, but there are no contribution limits.

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The "Set It and Forget It" Advantage

One of the most underrated benefits of index funds is behavioral. Because you're not making picks or trying to time the market, there's nothing to watch and no action to take. You contribute, you buy shares, you leave it alone.

This removes the temptation to panic-sell during downturns (which is how most active investors hurt themselves), over-trade based on news, or chase last year's hot sector. The index investor's job is to own the market and stay in the market. Time does the rest.

The math on staying invested is unambiguous. Missing just the 10 best days in the S&P 500 over a 20-year period — days you can't predict — can cut your returns by 50% or more. The only way to guarantee you don't miss them is to always be invested.

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The Case Is Closed

Index funds aren't a compromise or a fallback for people who don't know better. They're the optimal choice, confirmed by decades of data, endorsed by the greatest investors in history, and available to anyone with a brokerage account.

You don't need to be sophisticated. You don't need to watch CNBC. You don't need to pick stocks. You need to open an account, choose a low-cost index fund, contribute consistently, and let time do its work.