What an S&P 500 index fund is and why people buy it

An S&P 500 index fund is a mutual fund or exchange-traded fund (ETF) that holds shares in all 500 companies listed in the Standard & Poor's 500 index. When you buy one share of an S&P 500 fund, you own a tiny piece of 500 large American companies — Apple, Microsoft, Coca-Cola, and hundreds of others — all in a single purchase.

People invest in S&P 500 funds because they want broad exposure to the stock market without picking individual stocks. The fund does the picking for you: it automatically holds whatever companies make up the index at any given time. If a company drops out of the index, the fund sells it; if a new one is added, the fund buys it. You pay a small annual fee — often between 0.03% and 0.20% of your investment — and the fund handles the rest.

The S&P 500 has existed since 1957 and represents about 80% of the total value of the U.S. stock market. Historically, it has returned an average of roughly 10% per year over long periods, though individual years vary widely and past performance does not may provide future results.

Key Takeaways

  • You can buy S&P 500 index funds through a brokerage account (taxable), a 401(k), or an IRA, and each has different tax treatment and contribution limits.
  • Popular low-cost S&P 500 funds include Vanguard VOO, Fidelity FXAIX, and Schwab SWTSX, each charging less than 0.10% annually.
  • Opening a brokerage account takes 10 to 20 minutes online and requires basic personal information, a Social Security number, and a bank account to fund it.
  • You can invest a lump sum or set up automatic monthly contributions, and most brokerages allow you to reinvest dividends automatically.
  • S&P 500 funds are long-term holdings; short-term trading in and out typically costs you money in fees and taxes.

Where to open an account and what you need

You buy S&P 500 index funds through a brokerage — a company licensed to buy and sell securities on your behalf. The major brokerages for individual investors are Vanguard, Fidelity, Charles Schwab, E-Trade, and Interactive Brokers. Each offers S&P 500 index funds with low fees and allows you to open an account online in about 15 minutes.

To open a brokerage account, you will need a Social Security number, a valid ID, your current address, and a bank account to transfer money from. Most brokerages ask you to confirm your employment status and annual income, though they do not verify these details closely. You will also choose whether you want a standard taxable account or a retirement account (IRA or Roth IRA); if you are self-employed or have a side business, you may also open a SEP-IRA or Solo 401(k).

Once your account is open and funded, you can place an order to buy shares of an S&P 500 fund the same day. The order executes at the end of the trading day, and the shares appear in your account by the next morning.

Three popular S&P 500 index funds and their costs

The three most widely held S&P 500 index funds are Vanguard VOO, Fidelity FXAIX, and Schwab SWTSX. All three track the same index, hold the same 500 companies, and charge annual fees (called expense ratios) below 0.10%. The difference between them is negligible over time; your choice of brokerage matters more than your choice of fund.

Vanguard VOO charges 0.03% annually. Fidelity FXAIX also charges 0.03%. Schwab SWTSX charges 0.03%. If you invest $10,000, you pay $3 per year in fees across all three. Over 30 years, the difference between a 0.03% fee and a 0.10% fee amounts to roughly 2% of your total return — meaningful, but not dramatic.

Avoid S&P 500 funds with expense ratios above 0.20%; they are usually actively managed funds that try to beat the index and typically fail to do so after fees. Stick with index funds that simply track the S&P 500.

How to place your first order

Once your account is funded, log in to your brokerage and navigate to the "Buy" or "Trade" section. Search for the fund by its ticker symbol (VOO, FXAIX, or SWTSX). The system will show you the current price per share and ask how many shares you want to buy or how much money you want to invest.

If you have $5,000 to invest and VOO is trading at $450 per share, you can buy 11 shares for $4,950 and leave $50 in cash, or you can buy 10 shares and keep $500 in cash. Most brokerages allow fractional shares, meaning you can invest exactly $5,000 and own 11.11 shares if that is what the math works out to. Place the order during market hours (9:30 a.m. to 4 p.m. Eastern time on weekdays) and it executes at the closing price that day.

After your first purchase, you can set up automatic monthly investments if you want. Most brokerages call this a "recurring investment" or "automatic purchase plan." You specify an amount and a date each month, and the system buys shares automatically. This approach removes the temptation to time the market and spreads your purchases across different price points over time.

Tax treatment in different account types

A taxable brokerage account has no contribution limits and no restrictions on when you withdraw money, but you owe capital gains tax on any profit when you sell. If you buy $10,000 of VOO and it grows to $15,000, you owe tax on the $5,000 gain. You also owe tax on dividends the fund pays each year, even if you reinvest them.

A traditional IRA lets you deduct contributions from your taxes in the year you make them (up to $7,000 in 2024, or $8,000 if you are 50 or older), but you owe income tax on all withdrawals in retirement. You do not owe tax on gains or dividends while the money is in the account.

A Roth IRA does not give you a tax deduction now, but withdrawals in retirement are tax-free, including all gains. You contribute after-tax dollars, but the account grows tax-free. If you expect to be in a higher tax bracket in retirement, a Roth IRA is usually the better choice.

If you have a 401(k) through your employer, you can often buy S&P 500 index funds inside it. Contributions reduce your taxable income, and you do not owe tax on gains until you withdraw in retirement. This is usually the best place to start if your employer offers a 401(k) match.

Dividends and reinvestment

S&P 500 companies pay dividends — cash payments to shareholders — several times per year. The fund collects these dividends and either pays them to you in cash or reinvests them automatically to buy more shares. Most investors choose automatic reinvestment because it compounds your returns over time without requiring you to do anything.

In a taxable account, you owe tax on dividends in the year they are paid, even if you reinvest them. In a traditional IRA or 401(k), you do not owe tax on dividends. In a Roth IRA, dividends are tax-free. This is one reason retirement accounts are powerful: the tax deferral lets your money compound faster.

Common mistakes and how to avoid them

The most expensive mistake is selling during a market downturn. The S&P 500 drops 10% or more roughly every two years and 20% or more roughly every five years. If you sell after a 20% drop, you lock in the loss and miss the recovery. History shows that staying invested through downturns and waiting for recovery is far more profitable than trying to time the market.

A second mistake is chasing higher returns by switching to individual stocks or sector-specific funds. S&P 500 index funds are boring by design — they match the market, not beat it. That boring approach has outperformed 80% to 90% of professional stock pickers over 15-year periods. Resist the urge to do better; you will almost certainly do worse.

A third mistake is investing money you will need within five years. Stock prices fluctuate, and if you need the money during a down year, you may have to sell at a loss. Use a savings account or money market fund for money you need soon, and use index funds for money you can leave alone for at least five years.

Frequently Asked Questions

Can I invest in an S&P 500 fund if I do not have much money to start?

Yes. Most brokerages have no minimum investment, and fractional shares mean you can invest $100 or $500 and own a proportional piece of the fund. Start with whatever you can afford and add to it over time through automatic monthly contributions.

What happens if one of the 500 companies goes bankrupt?

The fund automatically removes it from the index and replaces it with another company. Your loss is limited to that company's weight in the fund — usually less than 0.5% — and the other 499 holdings cushion the impact. This is why owning 500 companies is safer than owning one.

Should I wait for a market crash to invest?

No. Trying to time the market costs most investors money. Research shows that investing a lump sum immediately beats waiting for a crash, even though crashes do happen. If you have the money now, invest it now. If you are saving gradually, invest monthly regardless of price.

Can I lose all my money in an S&P 500 fund?

Extremely unlikely. For that to happen, all 500 of the largest U.S. companies would need to fail simultaneously. The S&P 500 has never lost more than 57% in a single year (in 1931, during the Great Depression). Even after that loss, it recovered fully within a few years.

Do I need to rebalance my S&P 500 fund?

No. The fund rebalances itself automatically. You do not need to buy or sell anything unless your life circumstances change — for example, if you need to withdraw money or want to shift money between retirement and taxable accounts.