Fees

• The difference between index funds and actively managed mutual funds is that there are no fund managers deliberately making investment decisions with index funds. This saves investors a significant amount of money over the years since fees are much lower with index funds. There are only small fees to pay for administrative costs.
  
  

Types

• Most index funds mimic the holdings of the major stock market indexes. The Standard and Poor's 500 Index and the DJ Wilshire 5000 follow the entire stock market. The Russell 2000 only follows small company stocks. The MSCI EAFE follows international stocks in Europe and Asia. The Lehman Aggregate Bond Index follows the bond market. There are also smaller index funds that mimic more specialized sectors in the financial markets. These include technology, financial services and natural resources.
  
  

Market Capitalization

• The amount of each stock an index fund owns varies depending on market capitalization. This is the market value of the company's outstanding shares. If a company has outstanding shares worth twice as much as another company, the index fund will own twice as many shares of it. Index funds are therefore more heavily weighted toward larger company stocks. The money is invested proportionately the way money is invested in the market at large.
  
  

Pros and Cons

• There are pros and cons to investing in index funds. They perform well during bull markets when the stock market is growing. Index fund shares increase in value along with the market and lower fees increase profits when shares are sold. However, index funds decrease in value when there is a bear market. Since index funds are required to maintain holdings reflecting a particular index, they can not change holdings to react to a market downturn.
  
  

Performance

• In general, index funds tend to outperform most actively managed funds. Since fees for index funds also tend to be lower, this makes them a popular investment. Index funds tend to be longer term investments since investors are attempting to increase their portfolios with an expanding stock market. This results in lower share turnover and keeps fees low.