An index fund is a mutual fund or exchange-traded fund (ETF) that aims to match the return of a market index, such as the S&P 500, by holding the investments in that index instead of picking them. Because nobody is choosing stocks, index funds usually trade less and charge lower fees than actively managed funds.
How does an index fund work?
An index is a list of investments plus a set of rules for choosing and weighting them. The S&P 500, for example, measures 500 leading US companies, with larger companies carrying more weight. An index fund that tracks the S&P 500 buys those companies in the same proportions, either by holding every one of them (full replication) or by holding a representative sample that behaves like the whole index.
The index fund then does very little. When a company joins or leaves the index, the fund buys or sells it. When investors add money, the fund buys more of everything in proportion. According to the US Securities and Exchange Commission's Investor.gov, this passive approach usually means less trading, lower transaction costs, fewer realized capital gains and lower fees than actively managed funds.
Your result is the index return minus the fund's costs. The main cost is the expense ratio: the percentage of the fund's average net assets used each year to pay its operating expenses, shown in the fee table of the prospectus. The gap between the index return and the fund return is called tracking difference.
Where did index funds come from?
The first index mutual fund for individual investors was First Index Investment Trust, launched by John C. Bogle at Vanguard on 31 August 1976. It aimed to track the S&P 500 and raised a little over $11 million, far below its target; critics called it "Bogle's Folly". The fund is now the Vanguard 500 Index Fund. Index investing spread from there to bonds, international shares, ETFs and, more recently, digital assets.
Why do index funds often beat actively managed funds?
Active fund managers try to beat the market by choosing investments and timing trades. Before costs, all investors together earn the market return, so the average active dollar can only beat the index if it takes return from other active investors. After fees and trading costs, most active funds fall behind.
S&P Dow Jones Indices measures this in its SPIVA scorecards. In the SPIVA U.S. Scorecard for year-end 2025, 78.78% of actively managed US large-cap equity funds underperformed the S&P 500 over the one year to 31 December 2025, and 92.89% underperformed over the 20 years to the same date.
Fees compound over time. The table below shows $10,000 invested for 20 years at a hypothetical gross return of 7% a year. It is an illustration of fee drag, not a forecast.
| Annual fee | Value after 20 years | Cost of the higher fee |
|---|---|---|
| 0.05% | $38,337 | — |
| 1.00% | $32,071 | $6,266 less |
Index funds vs actively managed funds: what is the difference?
| Feature | Index fund | Actively managed fund |
|---|---|---|
| Goal | Match the index, minus costs | Beat a benchmark |
| Who decides what to buy | The index rules | A manager or team |
| Typical costs | Lower expense ratio and less trading | Higher fees for research and trading |
| Main risk | Falls with the whole market | Market risk plus the risk of poor manager decisions |
| Transparency | Holdings follow published rules | Holdings depend on the manager's choices |
What is a crypto index fund?
A crypto index fund applies the index idea to digital assets: it holds a basket of cryptocurrencies, and sometimes tokenized stocks or gold, according to published rules. The idea is the same as in stock markets, but the details differ enough that crypto index funds deserve their own guide. Our pillar article explains how crypto index funds work, including weighting, rebalancing, costs, custody and risks.
The biggest difference is concentration. Crypto markets are dominated by a few assets, so a crypto index weighted by market value is far less spread out than a broad stock index. In the Bitwise 10 Large Cap Crypto Index, bitcoin was 75.11% and ether 15.41% of the index at 31 December 2025, leaving under 10% for the other eight assets. Crypto index funds also come in more forms, from US-listed ETFs to baskets held on a blockchain; the types of crypto index funds guide sorts them by holdings, weighting and structure, and crypto index fund vs ETF compares the two most common wrappers.
How do traditional and crypto index funds compare?
| Feature | Traditional index fund | Crypto index fund |
|---|---|---|
| What it holds | Shares or bonds | Cryptocurrencies, sometimes with tokenized stocks, ETFs or gold |
| Market hours | Exchange trading hours | Underlying assets trade 24/7 |
| Concentration | Usually spread across hundreds of companies | Often dominated by bitcoin and ether |
| Price swings | Lower, though bear markets still hurt | Much larger and faster |
| Custody | Regulated custodian banks and brokers | Varies: ETF custodians, platforms or on-chain wallets |
| Income | Dividends or interest | Usually none |
| Regulation | Registered funds with investor protections | Ranges from registered ETFs to unregulated platform funds |
Are index funds a good choice for beginners?
For many beginners, a broad, low-cost index fund is a sensible starting point because it removes the need to pick winners and keeps costs low. Index funds still have limits that beginners should understand:
- You get the market return, including the falls. An index fund will not sidestep a crash.
- Not every index is diversified. Market-value weighting can leave a fund dominated by a few holdings, as the crypto example above shows.
- Not every index fund is cheap. Compare expense ratios and trading costs before you buy.
- The index rules matter. Read how assets are chosen, weighted and rebalanced.
If you are considering crypto specifically, our guide to crypto index funds for beginners walks through the first steps and the questions to ask.
How Wealtii fits in: Wealtii offers three funds that hold fixed baskets of crypto and tokenized assets at target weights set by its allocation methodology, with position caps. They are not weighted by market value, automated rebalancing is still in development, and Wealtii is not licensed or registered with any financial regulator. The Wealtii Digital Asset Core Index Fund is the all-crypto option; the methodology page explains how the weights are set.
Frequently Asked Questions
What is an index fund in simple terms?
An index fund is a fund that copies a market index instead of trying to beat it. If the index holds 500 companies, the fund holds the same 500 companies in roughly the same proportions, so your return closely follows the index, minus the fund's fees.
Can you lose money in an index fund?
Yes. An index fund rises and falls with the market it tracks. A stock index fund can drop sharply in a bear market, and a crypto index fund can fall even further because crypto prices are more volatile. Index funds remove the risk of picking the wrong company or coin, not the risk of the whole market falling.
Do index funds pay dividends?
Stock and bond index funds usually pass on the dividends or interest paid by their holdings, either as cash payouts or by reinvesting them. Most crypto index funds pay no income because most crypto assets pay none. Some crypto funds stake assets to earn rewards; Wealtii funds do not stake, lend or earn yield on their holdings.
What is the difference between an index fund and an ETF?
An index fund is a strategy, while an ETF is a structure. Many ETFs are index funds, but an index fund can also be a mutual fund that is bought and sold once a day at its closing value. ETF shares trade on a stock exchange throughout the trading day at market prices.
Sources & References
- U.S. Securities and Exchange Commission, Investor.gov — Index Fund (glossary) (accessed 21 Oct 2026)
- U.S. Securities and Exchange Commission, Investor.gov — Expense Ratio (glossary) (accessed 21 Oct 2026)
- Vanguard — 50 years. 50 facts. Indexing since 1976 (accessed 21 Oct 2026)
- S&P Dow Jones Indices — SPIVA U.S. Scorecard, Year-End 2025 (accessed 21 Oct 2026)
- Bitwise 10 Crypto Index ETF — Annual Report on Form 10-K for fiscal year 2025 (SEC EDGAR) (accessed 21 Oct 2026)
Disclaimer: This content is for educational purposes only and does not constitute financial, tax, or legal advice. Digital assets are volatile and you can lose some or all of the money you invest. Past performance does not guarantee future results. Wealtii is not licensed or registered with any financial regulator.
