Index mutual funds

Index mutual funds offer a cost-effective, potentially tax-efficient way to diversify your portfolio.

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What is an index mutual fund?

It's a mutual fund that tracks a specific market index. The goal: mirror the index's holdings, activity, and return.

  • They don't require a fund manager to actively select investments; instead, the vehicle buys a broad representation (or all) of the securities in an index.
     
  • They are generally more tax-efficient than actively managed mutual funds because there's less buying and selling of the fund's securities.
     
  • They generally have lower costs.

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What are some popular market indexes?

  • Dow Jones Industrial Average

    Consisting of 30 companies, "The Dow," as its usually called, is often quoted as a barometer of market performance. Most companies are listed on the New York Stock Exchange, but a few are on the Nasdaq Exchange.

  • S&P 500®

    Short for the "Standard & Poor 500," this index contains 500 of the largest U.S. companies, which are selected by a committee. It's generally considered to be a better market indicator than the "Dow" because of its coverage and market-cap methodology.

  • Nasdaq Composite

    This index consists of all the common stocks traded on the Nasdaq Exchange. Most are technology and internet-related, but there are financial, consumer, and biotech companies too. 

  • Schwab 1000®

    This index tracks 1,000 of the largest publicly traded U.S. companies, offering investors exposure to 90% of the total U.S. stock market. It's designed to capture the growth of both large and mid-sized companies.

What types of index mutual funds are there?

  • Traditional (or market-cap) index mutual funds

    This is a popular type of fund that tracks indexes weighting companies based on the market value of their stock or debt—also known as market capitalization. Most major indexes are market-cap indexes.

  • Fundamental (or factor) index mutual funds

    While these funds also track indexes, fundamental index funds track indexes that are not market-cap weighted and, instead, weight holdings based on a variety of economic factors. These factors, called fundamental measures, can include a company's adjusted sales, cash flow, dividends, and stock buybacks.

Learn more about low-cost Schwab Index Funds

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What are the pros and cons of index mutual funds?

  • Pros

    Cost-effective
    They generally have lower management fees than actively managed mutual funds.

     

    Tax-efficient
    Index funds don't change their holdings as often as actively managed funds, typically resulting in fewer taxable capital gains distributions. 

     

  • Cons

    No control over the holdings
    These funds provide access to a wide variety of investable markets; however, an index fund might not include a company you like or believe will perform well as they only track companies in the underlying index. 

     

    No downside protection
    Investing in an index fund means you're subject to market performance, even when markets fall. 

     

What are other factors to consider when choosing an index mutual fund?

All index mutual funds aren't created equal. It pays to take a closer look.

  • Strategy

    Which asset class does the fund provide exposure to? Is the index methodology clear and sensible?  For example, how does the index select and weight securities? How often does the fund rebalance the securities in its portfolio?

  • Performance relative to benchmark

    How has the fund performed relative to its benchmark, and in absolute terms? And not just at one year, but three, five, and 10 years? Has the fund tracked the same index over its entire life? 

  • Fees and costs

    What is the fund's operating expense ratio Tooltip ? Does the fund charge you to buy or sell its shares? What share classes does it offer?

Next steps

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