The best index fund depends on what you are saving for and how long you have to save
There is no single "best" index fund because different funds track different markets and charge different fees. A fund that works well for someone saving for retirement in 30 years may not work for someone who needs the money in five years. The right choice depends on three things: which market you want to track, how much you want to pay in fees, and how much risk you can handle if the market drops.
Most people choose between broad market funds (which own hundreds or thousands of stocks), sector funds (which own stocks in one industry), and bond funds (which own debt instead of stocks). Each type behaves differently when markets move. Knowing what you own and why you own it matters more than chasing the fund with the lowest fee or the highest recent return.
Key Takeaways
- Broad market index funds that track the S&P 500 or total U.S. stock market are the most common choice for long-term savers because they spread risk across many companies.
- Expense ratios (the annual fee charged by the fund) vary widely, and even a difference of 0.1% compounds into thousands of dollars over decades.
- International index funds and bond index funds serve different purposes and should not be chosen based on recent performance alone.
- The fund you choose matters less than starting early, adding money regularly, and not selling during market downturns.
Broad market funds versus focused funds
A broad market index fund owns a piece of hundreds or thousands of companies. The S&P 500 index fund owns 500 large U.S. companies. A total stock market fund owns nearly every publicly traded U.S. company. These funds are less likely to lose half their value overnight because no single company's failure can sink the whole fund.
A sector or focused index fund owns only stocks in one industry — technology, healthcare, energy, or finance. These funds can grow faster when that industry is booming, but they can also fall harder when that industry struggles. Someone who believes technology will outperform the rest of the market might choose a technology index fund, but they are betting on an outcome rather than diversifying.
For most people, especially those new to investing, a broad market fund is the safer starting point. You own the whole market instead of guessing which part will win.
How expense ratios affect your money over time
An expense ratio is the percentage of your money the fund company charges each year to run the fund. A fund with a 0.03% expense ratio charges $3 per year for every $10,000 you own. A fund with a 1% expense ratio charges $100 per year for the same $10,000.
Over 30 years, that difference compounds. If you invest $10,000 and it grows at 7% per year, a 0.03% fee leaves you with roughly $76,000. The same investment with a 1% fee leaves you with roughly $60,000. You lost $16,000 to fees alone, even though both funds tracked the same market.
Most large index fund providers — Vanguard, Fidelity, and Schwab — offer broad market funds with expense ratios between 0.03% and 0.10%. Actively managed funds (where a person picks stocks instead of tracking an index) often charge 0.5% to 1% or more. For index funds, lower fees almost always mean more money stays in your account.
Stock funds versus bond funds
Stock index funds own pieces of companies. Bond index funds own debt — loans that governments and companies have taken out. When stock markets fall, bond prices often stay steady or rise. When interest rates rise, bond prices fall.
A young person with 40 years until retirement might own 90% stock index funds and 10% bond index funds. Someone retiring in two years might own 40% stock and 60% bonds. The closer you are to needing the money, the more bonds make sense, because bonds are less likely to drop sharply right when you need to withdraw.
A common approach is to own a target-date fund, which is an index fund that automatically shifts from mostly stocks to mostly bonds as you approach a specific retirement year. You pick the fund labeled with your expected retirement year, and the fund rebalances itself without you having to do anything.
International index funds and home country bias
A U.S. stock index fund owns only U.S. companies. An international developed markets fund owns companies in Europe, Japan, Australia, and other wealthy countries. An emerging markets fund owns companies in faster-growing countries like India, Brazil, and Mexico.
Many people own only U.S. funds because they live in the U.S. and earn money in U.S. dollars. But the U.S. is not always the best-performing market. From 2000 to 2010, international stocks outperformed U.S. stocks. From 2010 to 2020, U.S. stocks won. A common approach is to own 70% U.S. stock index funds and 30% international stock index funds, so you benefit from both.
International funds carry extra risk because currency exchange rates can move against you. If the dollar strengthens, your international fund loses value even if the foreign companies are doing well. This is why some people stick with U.S. funds only, especially when starting out.
How to compare funds side by side
When you are deciding between two index funds, look at these four things in order:
- Do they track the same index? Two S&P 500 funds should behave almost identically. If they do not, one has higher fees or higher trading costs.
- What is the expense ratio? If both track the S&P 500, choose the one with the lower fee. The difference compounds over decades.
- What is the minimum investment? Some funds require $1,000 or $3,000 to open an account. Others have no minimum. If you are starting small, this matters.
- Can you buy it where you bank? If you use Fidelity, Fidelity's own index funds are usually easier to buy and may have lower fees than competitors' funds.
Do not choose a fund based on its recent performance. A fund that returned 15% last year may return 2% next year. Index funds that track the same market will have similar long-term returns, so fees and convenience are what actually matter.
Common mistakes when choosing an index fund
The biggest mistake is waiting for the "right time" to invest. Someone who invested $10,000 in an S&P 500 index fund on the worst day of 2008 (when the market was crashing) would have more money today than someone who waited for the market to recover first. Time in the market beats timing the market.
The second mistake is switching funds because one is outperforming another. If you own a total U.S. stock market fund and a technology index fund, and technology is booming, you might be tempted to move all your money into technology. But technology will not boom forever. Stick with your original plan unless your life circumstances change.
The third mistake is choosing a fund based on a single year's returns. A fund that returned 25% last year might return 5% this year. A fund that returned 2% last year might return 12% this year. Over 20 years, the difference in annual returns is usually small — often less than 1% — so fees matter far more than picking the hot fund.
Frequently Asked Questions
Should I choose a fund based on how well it performed last year?
No. Past performance does not predict future results, and index funds tracking the same market will have similar long-term returns. A fund that outperformed last year may underperform next year. Focus on fees and whether the fund tracks the market you want to own.
Is a 0.5% expense ratio really that bad compared to 0.05%?
Yes. Over 30 years, that 0.45% difference costs you roughly $100,000 on a $100,000 investment, assuming 7% annual growth. You are paying for active management that rarely beats the index, so the lower-cost index fund is almost always the better choice.
Can I own multiple index funds at the same time?
Yes. Many people own a U.S. stock index fund, an international stock index fund, and a bond index fund in the same account. This is called diversification. Avoid owning two funds that track the same index, because you are paying two sets of fees for the same holdings.
What if I only have $500 to invest right now?
You can still buy most index funds. Some funds have no minimum investment, and many allow you to buy fractional shares (a piece of one share) so you can invest any amount. Start with what you have and add more money when you can.
Should I choose an index fund or a target-date fund?
If you know how to split your money between stocks and bonds, choose an index fund. If you want the fund to rebalance automatically as you age, choose a target-date fund. Both are index funds; target-date funds are just more hands-off.