Index Fund

Rather than trying to pick winning investments, an index fund simply mirrors an index, such as a broad stock market index, a bond index or a sector index. Its returns closely follow the index, minus a small fee.

Index funds can be mutual funds or exchange-traded funds. Because they do not require teams of analysts selecting investments or frequent trading, they typically have much lower fees than actively managed funds.

For example, an index fund tracking an index of the 500 largest US companies holds shares in all those companies in proportion to their weights in the index. If the index rises 10% in a year, the fund rises by close to 10%, less its fee.

Index funds offer broad diversification, low costs, transparency and simplicity. The idea was popularised by John Bogle, founder of Vanguard, who launched one of the first index funds available to individual investors in the 1970s.

The trade-off is that index fund investors receive the market's full ups and downs and cannot outperform the index. They also hold every company in the index, regardless of whether it looks expensive or risky.