An index fund invests in selected stocks that try to mimic the average behavior of a large class of stocks.  More specifically:

An index is just a calculated number.  An index fund tries to make it into something that an investor can buy.  The fund differs from the corresponding index in several ways.

• The class that defines an index may contain hundreds of companies. This can be cumbersome to invest in, even with computers.  An index fund uses a smaller subclass of companies that tries to mimic the behavior of the entire class.  Typically, the value of an index fund tracks the exact index within 1% or so.
• One can invest in an index fund, but not in an index.
• An index fund keeps track of dividends and other income, normally reinvesting them. Thus, an index fund’s value slowly rises beyond what is shown by the index, which is based on share price alone.

An index fund is passively managed.  That is, there is little buying or selling of the stock in the index fund.  Occasionally the benchmark index will be adjusted and the index fund must be modified to follow this, but other than that no attention is required.

See also: