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Index funds and passive investing
1971 institutional; retail 1976· Asset or instrument
Fact, law or dataA rule, statute, definition or measured number.
An index fund buys every security in a market index to match its return at very low cost, instead of trying to beat it.
See it on the Money & Finance map →How it works
Rather than pay managers to pick winners, the fund holds the index in proportion, for example all S&P 500 companies weighted by market value. Wells Fargo built an institutional index fund in 1971; Vanguard opened one to the public in 1976. Many large S&P 500 index funds now charge 0.02–0.05% a year, versus roughly 0.6% for the average actively managed stock mutual fund. Individuals can buy them as mutual funds or ETFs at nearly any brokerage or in a 401(k).
Why it matters
Costs compound, so small fee savings grow large over decades. By the end of 2023, passive funds held more US fund assets than active ones.
Think of it like
Like owning a small share of every building in a metro area instead of trying to pick the single best one.
Facts, rules and data
Morningstar's fund data recorded passive overtaking active assets; SPIVA scorecards track how often active funds trail their indexes; the Investment Company Institute publishes average fees.
Debates and risks
Whether so much passive money distorts prices, inflates the biggest stocks or weakens shareholder oversight of companies is actively debated.
Inside this (4)
Connections (9)
▸Compound interest and the rule of 72 powers long-run returns in Index funds and passive investingFact, law or data
The connection
Index funds keep more of each year's return because fees are tiny, and that difference compounds. At 7% a year, $100,000 grows to about $761,000 in 30 years; at 6%, after a 1% fee, it grows to about $574,000. Reinvested dividends compound the same way. Bogle called it the tyranny of compounding costs.
When and why
Bogle made the argument from the 1970s on; the SEC illustrates fee drag in its 2014 investor bulletin on fees and expenses.
How we know
Plain arithmetic: fee savings are certain, while market returns are not. Fund cost data from ICI and Morningstar confirm the fee gaps.
Debates and risks
Future returns are unknown, so the dollar figures are illustrations; whether index returns near 10% a year will continue is debated.
▸Index funds and passive investing commonly track The S&P 500 indexFact, law or data
The connection
The S&P 500 is the most widely tracked index. A fund following it holds all 500 companies by market value, so growing firms automatically get bigger weights. When a stock joins the index, as Tesla did in December 2020, index funds must buy it, often pushing up its price.
When and why
Vanguard's first index fund tracked the S&P 500 in 1976, as did SPY in 1993; today Vanguard, BlackRock's iShares and State Street run the largest.
How we know
Fund prospectuses name the index; S&P Dow Jones Indices' annual survey counts trillions of dollars indexed to it.
Debates and risks
Whether heavy indexing inflates stocks added to the index, and whether its concentration in a few giants weakens diversification, are argued.
▸John Bogle and Vanguard launched the first retail Index funds and passive investingFact, law or data
The connection
Inspired partly by Paul Samuelson's 1974 call for an index fund, Bogle had Vanguard launch the First Index Investment Trust in August 1976, tracking the S&P 500 for ordinary investors. Rivals mocked it as 'Bogle's folly', but it became the Vanguard 500 Index Fund, one of the world's largest.
When and why
Valley Forge, Pennsylvania, August 1976; the first offering raised about $11 million against a $150 million goal.
How we know
Fund records and the prospectus, contemporary press coverage, and Bogle's own detailed accounts in his books.
Debates and risks
Credit is shared: Wells Fargo and others ran institutional index funds from 1971, and Samuelson, Malkiel and Fama supplied the reasoning.
▸Exchange-traded funds (ETFs) are an exchange-traded form of Index funds and passive investingFact, law or data
The connection
Most ETFs are index funds in a different wrapper: the same basket of holdings, but traded on an exchange during the day instead of bought from the fund once a day. The in-kind swap of shares for stocks also makes them more tax-efficient than most index mutual funds.
When and why
SPY, designed by Nathan Most at the American Stock Exchange with State Street, launched in January 1993.
How we know
Prospectuses and Investment Company Institute data show most ETF assets sit in index-tracking funds.
Debates and risks
Active ETFs have multiplied since the SEC's 2019 ETF rule; whether 'ETF' will keep meaning 'index fund' is uncertain.
▸Index funds and passive investing began as a type of Mutual fundsFact, law or data
The connection
The first public index fund was a mutual fund: investors bought shares directly from the fund company at the end-of-day price, like any other mutual fund. Indexing simply replaced the stock picker with a rule. Index mutual funds still hold trillions, though ETFs now draw much of the new money.
When and why
Vanguard's 1976 fund; mutual funds themselves date back to the Massachusetts Investors Trust in 1924.
How we know
Fund registrations under the Investment Company Act of 1940 and prospectuses; Morningstar and ICI track index mutual fund assets.
Debates and risks
Whether index mutual funds keep their place as ETFs, with their tax advantages and intraday trading, take most new money, especially in taxable accounts.
▸Efficient market hypothesis is the theory behind Index funds and passive investingMainstream view
The connection
If prices already reflect what is knowable, stock pickers as a group cannot reliably beat the market after costs, so the practical answer is to own the market cheaply. Burton Malkiel urged a no-frills index fund in 1973, and Paul Samuelson in 1974. William Sharpe later showed the case holds by arithmetic alone.
When and why
Fama (1970), Malkiel's A Random Walk Down Wall Street (1973), Samuelson (1974), Vanguard (1976), Sharpe's 'The Arithmetic of Active Management' (1991).
How solid is the link?
SPIVA data show most active funds trail their indexes; Sharpe's arithmetic holds whether or not markets are fully efficient.
Debates and risks
The Grossman-Stiglitz paradox (1980): if everyone indexed, no one would research prices, and markets could not stay efficient.
▸Warren Buffett and value investing recommends for most people Index funds and passive investingFact, law or data
The connection
Buffett, himself a famed stock picker, has long said most people should own a low-cost S&P 500 index fund. His will directs that 90% of the cash left for his wife go into one, with 10% in short-term government bonds. He also bet $1 million that an index fund would beat hedge funds over ten years, and won.
When and why
Berkshire Hathaway letters, especially the one for 2013; the bet with Protégé Partners ran 2008–2017, with proceeds going to Girls Inc. of Omaha.
How we know
His published letters; the S&P 500 fund gained about 126% over the bet versus about 36% for the hedge-fund picks.
Debates and risks
Buffett beat the market for decades; whether his record disproves efficient markets or is a rare, hard-to-identify exception is debated.
▸Retirement accounts and pension funds: 401(k)s, IRAs, pensions channel trillions of dollars into Index funds and passive investingFact, law or data
The connection
Every paycheck, 401(k) contributions buy funds automatically, and the default choice is usually a target-date fund built largely from index funds. The 2006 Pension Protection Act encouraged automatic enrollment and such defaults. The federal employees' Thrift Savings Plan is built mainly from index funds.
When and why
Since the Pension Protection Act of 2006; the federal Thrift Savings Plan has offered index funds since 1988.
How we know
Vanguard's annual How America Saves report shows most participants in target-date funds; ICI tracks 401(k) assets by fund type.
Debates and risks
Whether steady, price-insensitive buying from paychecks props up stock prices, the passive-flows debate, is argued among economists.
▸Norway's Government Pension Fund Global (the oil fund) follows the approach of Index funds and passive investingMainstream view
The connection
The Finance Ministry gives the fund a benchmark built from broad global stock and bond indexes, and NBIM must stay close to it, with only small active bets. The result resembles a total-world index fund: over 7,000 companies, annual costs of a few hundredths of a percent, and returns that track world markets.
When and why
Oslo; managed by Norges Bank Investment Management since 1998.
How solid is the link?
The ministry's published mandate and NBIM's reports on costs and returns relative to the benchmark.
Debates and risks
NBIM's active bets have added small gains over the benchmark; whether that justifies their cost and complexity is debated.