Index Funds & ETFs
What is an Index Fund?
An index fund is a type of mutual fund that tracks a market index instead of trying to beat it. The fund simply buys all (or a representative sample of) the stocks in an index like the S&P 500.
No stock picking. No market timing. Just match the market.
What is an ETF?
An ETF (Exchange-Traded Fund) works like an index fund but trades on stock exchanges like a regular stock. You can buy and sell ETFs throughout the day at market prices.
Index Fund vs ETF:
| Feature | Index Fund | ETF |
|---|---|---|
| Trading | Once daily at end-of-day price | Throughout the day like stocks |
| Minimum investment | Often €1,000+ | Price of 1 share |
| Fees | Low | Often slightly lower |
| Tax efficiency | Standard | Can be more tax-efficient |
Most ETFs are index funds. The main difference is how you buy them. Note: some ETFs are actively managed or use leverage - as a beginner, stick to plain index ETFs.
Popular Indices
- S&P 500 - 500 largest US companies
- MSCI World - ~1,500 companies across developed markets
- FTSE All-World - Global stocks including emerging markets
- Euro Stoxx 50 - 50 largest Eurozone companies
- Total Bond Market - Broad bond exposure
Why Passive Beats Active (Usually)
Here's the uncomfortable truth for active managers:
- Over 15 years, ~90% of active funds underperform their benchmark
- The few that outperform rarely do so consistently
- After fees, the odds are stacked against active management
Why? Thousands of professional analysts study the same stocks every day. When everyone is looking for bargains, prices quickly adjust to reflect all available information. This makes it very hard to consistently find "hidden gems" before everyone else does. And even when a manager does find one, the higher fees they charge often eat up any extra gains. The index fund doesn't try to be clever - it just owns everything and charges almost nothing.
The Cost Advantage
Index funds are cheap because there's no expensive research team or star manager to pay.
Typical expense ratios:
| Fund Type | Expense Ratio |
|---|---|
| Active Mutual Fund | 0.5% - 1.5% |
| Index Fund | 0.1% - 0.4% |
| Low-Cost ETF | 0.03% - 0.2% |
Example: S&P 500 index funds from major providers charge as low as 0.03% - that's €3 per year on €10,000.
Why different providers for the same index? The S&P 500 is just a list of 500 companies maintained by S&P Global. Anyone can create a fund that tracks it - Vanguard, BlackRock (iShares), Fidelity, and others all offer their own S&P 500 funds. They all hold the same stocks in nearly identical proportions - because the index itself defines the weights (based on each company's market cap). So if Apple is 7% of the index, every S&P 500 fund holds ~7% in Apple. Minor differences can occur due to timing of rebalancing, how they handle dividends, and small cash holdings for liquidity - but these are negligible. Providers mainly compete on fees and platform availability. This competition is good for investors - it drives fees down.
What to Watch Out For
- Tracking Error - How closely the fund follows its index. Lower is better.
- Liquidity - For ETFs, check trading volume. Low volume = wider bid-ask spreads.
- Fund Size - Very small funds may close or have higher costs.
- Currency Risk - If you buy a US index fund (like S&P 500), your returns are affected by the EUR/USD exchange rate - even if the ETF is priced in EUR. The trading currency is just for convenience; the underlying US stocks are still valued in USD. If the euro strengthens against the dollar, your returns shrink even if the index goes up. To actually remove currency risk, look for ETFs labeled "EUR Hedged" - these use derivatives to neutralize currency movements, but cost more (typically +0.1-0.3% expense ratio).
- Accumulating vs Distributing - When companies in the fund pay dividends, what happens to that money?
- Distributing funds pay dividends out to you (you receive cash, usually quarterly). You may owe taxes on each payment.
- Accumulating funds automatically reinvest dividends back into the fund (your shares grow in value instead). In many European countries, this is more tax-efficient because you only pay taxes when you eventually sell, not on each dividend payment.
Key Takeaways
- Index funds track a market index instead of trying to beat it
- Most ETFs are index funds that trade like stocks
- Low fees compound into significant savings over decades
- Most active managers fail to beat index funds long-term
- A simple 2-3 fund portfolio can provide global diversification. For example: one global stock ETF (like MSCI World or FTSE All-World) gives you exposure to thousands of companies across dozens of countries. Add a bond ETF for stability, and optionally an emerging markets ETF for growth potential.
Not financial advice. Always do your own research.
Last updated: February 2026