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

An S&P 500 index fund is a fund that holds shares in 500 large U.S. companies — the same 500 companies tracked by the Standard & Poor's 500 index. When you buy a share of the fund, you own a tiny piece of all 500 companies at once. Most people use index funds as a long-term investment because the cost is low, the diversification is automatic, and you do not have to pick individual stocks.

The fund's value rises and falls with the overall health of those 500 companies. Over the past 90 years, the S&P 500 has returned an average of about 10 percent per year, though some years it gains 20 percent and others it loses 10 percent or more. That historical average is why many investors treat index funds as a core holding — not a way to get rich fast, but a way to build wealth over decades.

Key Takeaways

  • You can buy S&P 500 index funds through a brokerage account (online or at a bank), and most brokerages charge no commission to buy or sell.
  • The fund itself charges a small annual fee called an expense ratio, usually between 0.03 and 0.20 percent per year depending on which fund you choose.
  • You need at least $1 to start, though some funds have minimums of $1,000 or $3,000 for the first purchase; many brokerages let you start with any amount if you set up automatic monthly deposits.
  • Popular S&P 500 index funds include VOO and SPY (both charge 0.03 percent annually), and VTSAX (0.04 percent); the differences are small enough that the brokerage you choose matters more than which fund you pick.
  • You can hold the fund in a regular taxable account, or inside a tax-advantaged account like a 401(k) or IRA, which changes how much you owe in taxes each year.

Opening a brokerage account and choosing where to buy

To buy an S&P 500 index fund, you need a brokerage account — a place where you deposit money and then use it to buy investments. Most major brokerages charge nothing to open an account and nothing per trade. The largest are Fidelity, Vanguard, Charles Schwab, E-Trade, and Robinhood; smaller regional banks and credit unions also offer brokerage services.

The account opening process takes 10 to 15 minutes online. You provide your name, address, Social Security number, and employment information. The brokerage verifies your identity and then gives you access to buy and sell. You then transfer money from your bank account into the brokerage account — this usually takes one to three business days. Once the money is there, you can buy the fund immediately.

The choice of brokerage matters less than you might think. All of them offer the same major S&P 500 index funds. What differs is the user interface, customer service quality, and whether they offer other services you want (like financial advice or retirement planning tools). If you already have a bank account or 401(k) somewhere, starting at that same institution can simplify your life, but it is not required.

Which S&P 500 index fund to choose

The three most common S&P 500 index funds are VOO (Vanguard S&P 500 ETF), SPY (SPDR S&P 500 ETF Trust), and VTSAX (Vanguard S&P 500 Admiral Shares mutual fund). All three hold the same 500 stocks and charge nearly identical fees — between 0.03 and 0.04 percent per year. The difference between them is technical: VOO and SPY are exchange-traded funds (ETFs), which trade like stocks throughout the day; VTSAX is a mutual fund, which prices once per day after the market closes.

For most people starting out, the choice between these three does not matter. Pick whichever your brokerage makes easiest to buy, or whichever has the lowest minimum investment. If your brokerage is Vanguard, VTSAX is the natural choice. If you are at Fidelity or Schwab, VOO is common. If you are at E-Trade or another broker, SPY is widely available.

Avoid funds with expense ratios above 0.20 percent per year. Some S&P 500 funds charge 0.50 percent or higher; over 30 years, that extra cost compounds into thousands of dollars in lost returns. Stick to the low-cost versions.

How much money to start with and how often to add

You can start with as little as $1 at most brokerages, though some funds have minimums of $1,000 or $3,000 for the first purchase. If your brokerage has a minimum you cannot meet right now, ask whether they offer automatic investment plans — many will let you start with $50 or $100 per month and waive the minimum.

Most people who build wealth through index funds do so by investing the same amount every month, regardless of whether the market is up or down. This is called dollar-cost averaging. If you invest $500 per month for 30 years, you will have invested $180,000 total; at a 10 percent average annual return, that grows to roughly $1 million (though past performance does not may provide future results). The key is consistency, not the size of each deposit.

Start with whatever amount you can afford to leave invested for at least five years. If you might need the money sooner, keep it in a savings account instead. Money in an index fund can drop 20 or 30 percent in a bad year, and you do not want to be forced to sell during a downturn.

Tax considerations: regular accounts versus retirement accounts

You can hold an S&P 500 index fund in two types of accounts: a regular taxable brokerage account or a tax-advantaged retirement account like a 401(k), IRA, or Roth IRA. The difference is how much you owe in taxes.

In a taxable account, you pay capital gains tax when you sell the fund at a profit, and you pay tax on any dividends the fund distributes (usually once per year). If you hold the fund for more than one year before selling, you pay long-term capital gains tax, which is lower than ordinary income tax. In a Roth IRA, you pay no tax on gains or dividends ever — but you can only contribute $7,000 per year (as of 2024) and you cannot withdraw the money until age 59½ without a penalty. In a traditional 401(k) or IRA, you get a tax deduction when you contribute, but you pay ordinary income tax when you withdraw.

For most people, the order is: first, contribute to your employer's 401(k) up to any company match (assistance programs). Second, max out a Roth IRA if you are may be able to access. Third, put any remaining money in a taxable brokerage account. But if you are just starting out and do not have access to a 401(k), a taxable account is fine — the tax drag is small compared to the benefit of starting early.

What happens after you buy: holding and rebalancing

Once you own shares of an S&P 500 index fund, you do not have to do anything. The fund automatically holds all 500 stocks and rebalances itself when companies are added or removed from the index. You will receive a statement each quarter showing your balance, and once per year the fund will distribute dividends (usually reinvested automatically into more shares).

The hardest part of index fund investing is not buying — it is holding. When the market drops 20 percent in a few months, many people panic and sell. Historically, every market crash has been followed by a recovery, but there is no may provide the next one will be. If you cannot stomach seeing your balance drop without selling, you may want to keep some money in a savings account instead, or invest smaller amounts over time so you feel less pain from any single downturn.

If you are investing money from multiple sources — a paycheck, a bonus, an inheritance — you can buy the fund whenever the money arrives. You do not need to wait for a "good time" to invest. Research shows that time in the market beats timing the market.

Common mistakes to avoid

The most common mistake is not starting at all because you think you need a large sum of money or perfect knowledge. You do not. Starting with $100 per month beats waiting two years to save $5,000.

The second mistake is selling during a market downturn. If you are investing for 10 or more years, a 30 percent drop is a buying opportunity, not a reason to exit. If you cannot tolerate that volatility, reduce the amount you invest or hold some money in bonds instead.

The third mistake is chasing performance. Some years, individual stocks or other funds outperform the S&P 500. This tempts people to switch. But over long periods, the S&P 500 beats most other strategies. Stick with it.

The fourth mistake is paying high fees. If your brokerage charges $10 per trade or your fund charges 0.50 percent per year, move to a low-cost provider. Over 30 years, high fees can cut your returns in half.

Frequently Asked Questions

Do I need to pick individual stocks, or is an index fund enough?

An index fund is enough for most people. Picking individual stocks requires research, time, and luck — most professional stock pickers do not beat the S&P 500 over 15-year periods. If you want simplicity and historically solid returns, an index fund is the better choice. You can always add individual stocks later if you want to experiment with a small portion of your money.

What if the market crashes right after I invest?

Market crashes are normal and temporary. If you invest $5,000 and the market drops 20 percent the next month, your $5,000 is now worth $4,000 on paper. But if you hold it for 10 more years, history suggests it will be worth much more than $5,000. The key is not needing the money in the short term. If you might need it within five years, keep it in a savings account instead.

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

Theoretically, yes — if all 500 companies went bankrupt simultaneously. Practically, no. That would require a catastrophe far worse than any event in modern history. The worst one-year loss in S&P 500 history was about 37 percent (in 2008). Even then, investors who held on recovered their money within a few years.

Should I wait for the market to drop before I invest?

No. Timing the market is nearly impossible, and waiting costs you money. If you invest $500 per month for 30 years, you will buy some shares when the price is high and some when it is low — that is the benefit of dollar-cost averaging. Research shows that investors who invest a lump sum immediately beat those who wait and invest gradually.

What is the difference between an ETF and a mutual fund?

ETFs (like VOO and SPY) trade throughout the day like stocks, so you can buy or sell at any time. Mutual funds (like VTSAX) price once per day after the market closes. For S&P 500 index funds, the difference is negligible. ETFs are slightly more tax-efficient in taxable accounts, but the advantage is small. Pick whichever your brokerage makes easiest to buy.