Vanguard ventured into uncharted waters when we launched the first index fund for individual investors in 1976. Index funds turned the tide for individual investors seeking broad market exposure and low costs. And they’re still making waves.

Index funds vs. active funds

An index fund is an ETF (exchange-traded fund) or mutual fund that tracks a benchmark—a standard or measure that reflects a specific asset class. The fund is designed to act just like the benchmark it tracks, and for this reason, index funds are passive funds. If a fund’s benchmark goes up or down in value, the fund follows suit.

An active fund is an ETF or mutual fund that’s actively managed by a fund advisor who chooses the underlying securities that comprise the fund with the goal of outperforming a specific benchmark. If a fund advisor picks the right mix of securities, the fund may outperform the market. But there’s always the risk that poor security selection will cause the fund to underperform the market.

Here are 3 good reasons to invest in index funds.

  1. Keep more investment returns.

    Index funds generally have lower expense ratios than active funds because they don’t have the added expense of paying a fund advisor to continuously research and select securities to hold within the fund. An expense ratio reflects how much a fund pays for administrative expenses, including portfolio management, and is reflected as a percentage of the fund’s average net assets. This means if a fund has an expense ratio of 0.10%, you’ll pay $1 for every $1,000 you’ve invested in the fund—an amount that’s deducted automatically from your investment return.

    It’s important to note that not all index funds are created equal. Vanguard index mutual funds and ETFs have an additional advantage: Their average expense ratio is 73% less than the industry average.*
  2. Pay less tax.

    Because an index fund tracks a benchmark, the fund makes few trades, which means it doesn’t generate a lot of capital gains. Capital gains are profits from selling a security for a higher price than was originally paid.

    If a fund sells an underlying security for a profit, it’s required to pass along the earnings to its shareholders as a distribution at least once per year. If you hold a fund that makes a distribution in a taxable (e.g., nonretirement) account, these distributions are counted as income and subject to taxes.
  3. Easily create a diversified portfolio.

    You can build a diversified portfolio that represents all sectors of the market by holding just 4 total market index funds. Keep in mind, your asset allocation—how much you invest in each of these 4 index funds—will depend on your investing goals, time frame, and risk tolerance.

Build a diversified portfolio with just 4 index funds

These 4 total market index funds—when used in combination—cover nearly all aspects of the U.S. and international stock and bond markets, which can help reduce your overall investment risk while making it easier to manage your portfolio. The funds are available as ETFs or mutual funds. (Not sure what to choose? We can help.)

Ready to invest in index funds?

Discover the advantages of passive investing.

*Vanguard average expense ratio: 0.07%. Industry average expense ratio: 0.23%. All averages are for index mutual funds and ETFs and are asset-weighted. Industry average excludes Vanguard. Sources: Vanguard and Morningstar, Inc., as of December 31, 2019.

Notes:

All investing is subject to risk, including the possible loss of the money you invest.

Diversification does not ensure a profit or protect against a loss.

There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments. Investments in bonds are subject to interest rate, credit, and inflation risk.

For more information about Vanguard funds or Vanguard ETFs, visit vanguard.com to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

You must buy and sell Vanguard ETF Shares through Vanguard Brokerage Services (we offer them commission-free) or through another broker (which may charge commissions). See the Vanguard Brokerage Services commission and fee schedules for full details. Vanguard ETF Shares are not redeemable directly with the issuing fund other than in very large aggregations worth millions of dollars. ETFs are subject to market volatility. When buying or selling an ETF, you will pay or receive the current market price, which may be more or less than net asset value.

"3 good reasons to invest in index funds", 5 out of 5 based on 194 ratings.