Concepts of INDEX FUNDS
By Ethan Yan | February 6, 2026
What is an index fund?
To understand an Index Fund, you must understand what a Market Index is first. A Market Index is a list of preselected companies where it tracks their total average performance, creating a benchmark for stock market performance. There are many kinds of Market Indexes, but the most popular are: Dow Jones, NASDAQ, and S&P 500.
An Index Fund is an investment type that an individual can buy shares of from a brokerage firm. Just like how there are many Market Indexes, there are different kinds of Index Funds based on your brokerage firm. For example, there is Vanguard S&P 500, Fidelity S&P 500, and Schwab S&P 500. Each will provide their own different APY, which won’t be discussed in this blog, so do your own research on what fits bests for you.
The Upsides and Downsides of Index Funds
PROS
Lower Risk
Unlike purchasing individual stocks, Index Funds automatically diversifies your money into a pool of preselected companies.
If Apple performed poorly during the year, you would lose money on your investment. On the other hand, an Index Fund provides some security because other companies may perform amazing, which will offset Apple’s poor performance.
Long Growth Potential
Index Funds aren’t a get rich quick type of investment. The key is to take advantage of the compounded interest it provides. The longer you hold, the more you’ll benefit.
The average market return is 10%, meaning that in order to double your principal amount, it would take roughly 7 years. Keep in mind, this is a rough estimate, as it can be earlier or later than 7 years.
Passive Investment
Index Funds are primarily low maintenance type of investment. Considering you have to wait about 7 years to get its full value, you don’t have to constantly research about your investment, nor time the market on when to sell.
Real Life Scenario
Figure 1 shows the performance of the NVIDIA Stock (NVDA) and Fidelity S&P 500 Index Fund (FXAIX) in the last 5 years. The information is pulled from Yahoo! Finance, where I used the the adjusted closing price at the beginning of each year. The pattern we can see is that they are both positive from where they started in 2021. However, we can see really see the high upsides of investing in an individual stock when we analyze their adjusted closing prices and how much value they’ve grown in the last 5 years.
Adjusted closing price
NVIDIA (Up 1343.80%)
2021 $13.08
2022 $30.06
2023 $14.30
2024 $48.14
2025 $138.27
2026 $188.85
Fidelity (99.37%)
2021 $119.49
2022 $157.07
2023 $127.26
2024 $160.46
2025 $201.28
2026 $238.23
Although the market has performed well since 2021, we can see that NVIDIA made way more money than Fidelity. A single share of an NVIDIA stock went up 14x more than its original value in 2021. On the other hand, Fidelity only doubled. We can see how the pros and cons weigh in, but this might entice you to invest in a successful stock like NVIDIA instead of an Index Fund. In Figure 2, we can see the downsides and the risk of a company stock.
Adjusted closing price
CONS
Underperforming the Market
One of the greatest rules to remember is that a lower risk investment will always result in a lower reward.
An individual stock will always provide faster and greater reward than an Index Fund. It can equally fail and provide a loss. For a real example, look at the Real Life Scenario section.
Slow Growth
If you’re looking for faster wealth growth, Index Funds can’t provide that achievement.
Taking out any money early would negatively impact your investment. Sure you get short term reward, but it will take longer for you to double your principal.
Considered “Boring”
Remember that it’s a passive investment. For some, this is great since you don’t have to time the market, nor keep up with the news as often.
However it’s not for everyone, so if you want a more active investment, individual stock investments may seem more attractive.
individual stocks vs index funds
Figure 1.
Figure 2.
BlackBerry Stock
BlackBerry was revered as a tech powerhouse in 2006 to 2008. Unfortunately it peaked in 2008, where it dramatically fell off in the next 5 years. We can see from the dramatic price drop and it hasn’t recovered since. From today’s date, February 6th, 2026, it is worth $3.40 per share. Use this as an example of a company that seems to be flourishing just suddenly drop in value. Stocks are hard to predict and most investors are never right.
BlackBerry(Down 89.69%)
2008 $113.71
2009 $41.92
2010 $65.93
2011 $58.94
2012 $15.51
2013 $11.72
Realizing the Gains
If you don’t understand the difference between dividends and capital gains that companies can give out, take a look at this blog post where I cover it: [Click Here]
Investing in an Index Fund is going to be an unrecognized gain/loss in capital gains. It’ll only be recognized when you decide to sell a portion of your shares. There are two things a brokerage firm will allow you to do when your Index Fund makes money: Automatically reinvest into the Index Fund or to pull the money out. Again to take advantage of the Index Fund, you should automatically reinvest into the Index Fund. Keep in mind, the investment can always dip, but it’ll always bounce back.
Example:
If you invested $1000 to the S&P 500 Index Fund, and in Year 1 you lost 5%, leaving you with $950 at the start of the following year. At the end of Year 2, you gained 7.9% on your $950, so now your ending value is $1025. Keep in mind, Index Funds are compounded interest investments, so the longer you hold the more valuable it will be.
If you haven’t read what are great starting accounts to have, I’ve talked about it in my Banking and Retirement blog!
Why a Brokerage Account?
Remember what a Roth IRA is: a retirement account where you put money in that has paid taxes already. So even if you invest in the same exact Index Fund, like FXAIX, any money gained from the Roth IRA isn’t taxed. So when you’ve retired, you can take advantage of the tax free money. On the other hand, a Brokerage Account will be taxed when you decide to realize the gains. However there isn’t a max amount that you can invest in a year. It’s a great investment to have outside of retirement accounts. Both are compounded interest, but with differing tax benefits.
Opening a brokerage account may be difficult. There are many firms out there and you should do deep research on which one fits you best. However, here is a rough guide on what you should look for in these firms:
Minimum Investment Amount
Depending on the brokerage account and the type of investment you’re interested, there may be a minimum investment amount. For example, Vanguard Index Funds may require up to $3000 for a minimum investment. This is not particularly attractive for a new investor with little extra cash. Some find Vanguard reputable and worth the minimum investment, as they may provide different benefits for using their services.
Transaction Fees
Keeping the same example, if you have a Vanguard Account and you want to purchase shares of FXAIX, you will be charged a greater transaction fee due to it being a competitor brokerage firm. However, if you buy the Vanguard S&P 500 Index Fund, VFAIX, there will be little to no transaction fees. On average, there will be some transaction fees when you purchase an investment. Typically it’s a low amount like 0.01%. One thing for sure is that you don’t want to go above 0.05% in transaction fees.
Reputation
What makes the top brokerage firms stand out from starting firms is their reputation. They’ve been in the business for a long time, so you can ensure that your money will be a lot safer and their systems to reliable. Although newer firms may provide different benefits, so be sure to thoroughly research when you start your investment journey.