An index mutual fund is a type of fund that invests all, or nearly all, of its total assets in securities comprising its underlying index. Index funds use passive investment strategies and thustend to have low turnover and low expense ratios.
Funds that implement indexing strategies require less portfolio management and active trading, which minimizes their operating fees. Index funds with lowexpense ratiosbenefit long-term investors who seek to track indexes and gain exposure to select market segments over time.
Key Takeaways
- A growing number of index funds continue to be developed. This including the evolution of smart beta index funds, which seek to replicate customized indexes.
- Expense ratios are a factor that investors may consider when choosing between passive fund investments and active managers.
- The Fidelity 500 Index Fund (FXAIX), the Vanguard Value Index Fund Admiral Shares (VVIAX) fund, and Fidelity U.S. Bond Index Fund (FXNAX) are among the lowest expense ratio mutual funds.
Expense Ratios and Management Fees
Expense ratios and management fees are part of an ongoing debate waging passive funds against active funds in the marketplace. A growing number of index funds continue to be developed in the market, including the evolution of smart beta index funds that seek to replicate customized indexes.
To date, the debate on the added value of active management versus the advantages of passively managed funds continues. Expense ratios are often one of the key factors that may sway investors to choose passive fund investments over active managers when seeking targeted investment options.
As of the second quarter of 2023, the following three funds were among the lowest expense ratio mutual funds, as reported by Morningstar. These funds were chosen based on expense ratio, retail investment availability, and broad market exposure.
1. The Fidelity 500 Index Fund (FXAIX)
The Fidelity 500 Index Fund (FXAIX) is an investor-class fund marketed by Fidelity with a net expense ratio of just 0.015%. The fund tracks the holdings and return of the S&P 500 Index. The fund invests at least 80% of its total assets in the S&P 500 Index. The fund requires no minimum investment. It had a 2022 annual return of -18.13% versus -18.11% for its benchmark index.
2. The Vanguard Value Index Fund Admiral Shares (VVIAX)
The Vanguard Value Index Fund Admiral Shares (VVIAX) fund is marketed by Vanguard. It tracks the holdings and performance of the CRSP U.S. Large Cap Value Index. The fund has a net expense ratio of 0.05%. It does require a minimum investment of $3,000. For 2022, the fund had a one-year return that was 2.01%, behind the Index.
3. The Fidelity U.S. Bond Index Fund (FXNAX)
The Fidelity U.S. Bond Index Fund (FXNAX) falls in Morningstar's "Intermediate-Term Bond" category. The fund is focused on U.S. bond investments. It has an expense ratio of 0.025% and requires no minimum investment.
The fund invests at least 80% of its assets in bonds in the Bloomberg U.S. Aggregate Bond Index. Its 2022 return was -13.04% versus -13.01% for the benchmark.
What Does an Expense Ratio Pay For?
Expense ratios cover the costs of managing the fund. Since index funds buy small pieces of every fund in an index, they take little management and charge much lower expenses. Actively managed funds, such as mutual funds, have higher fees to cover the costs of the managers that choose the stocks.
Are Index Funds Guaranteed to Make Money?
Investing money in the stock market is a gamble. There are no guarantees that any index, mutual fund, or bond will make money, and no insuring body like the Federal Deposit Insurance Company (FDIC) to cover losses in the event of failure. However, historically, various indices like the S&P 500 and the Dow Jones Industrial Index have risen in value over time. By investing money across several stocks in an index or mutual fund, investors lessen the risk of losing all of their investment.
How Much Money Do I Need to Start Investing in Index Funds?
Every index fund is different—some require an initial investment of a specific dollar amount, after which investors may contribute money in any denomination. Others have no minimum spending threshold. Check the fund profile on the parent company's website to find out the minimum purchase. Information such as minimum purchase amount, expense ratios, and historical performance will be available.
The Bottom Line
These funds must be traded with their affiliated platform, which is a factor that helps to keep the expense ratios down. The limited but easy access through the Fidelity and Vanguard trading platforms helps to limit many of the distribution and 12b-1 fees, keeping the expenses lower for investors.
