What is a stock index fund designed to track?

A stock index fund is designed to track a market index. It generally holds the index’s constituent securities, or a representative sample, with the goal of matching the index’s performance rather than selecting individual winners through frequent active trading.

Index funds can be mutual funds or exchange-traded funds. Their performance usually differs slightly from the target index because of fees, taxes, trading costs, cash holdings, sampling methods, and the timing of portfolio changes. This difference is called tracking error.

An index fund does not eliminate investment risk. If the tracked index falls, the fund’s value will normally fall as well. However, broad index funds can provide diversification across many companies, industries, or countries in a single investment. The first index mutual fund available to retail investors in the United States was created by Vanguard in 1976 and later became known as the Vanguard 500 Index Fund.