Index fund — what it is and how it works

Definition

Index fund is an investment fund whose goal is to replicate the performance of a specific stock market index (e.g., WIG20, S&P 500, MSCI World). Instead of trying to "beat the market" (like active funds), an index fund simply copies it.

Quick Answer

An index fund is a passively managed investment fund that replicates a stock market index such as the S&P 500 or WIG20, buying stocks in the same proportions the index holds them rather than trying to beat the market. Because an algorithm maintains the composition with no manager picking securities, costs stay low — typically a TER of 0.1–0.5%. This matters because SPIVA studies show 85–95% of active funds lose to their benchmark after 15 years, so low fees compound into a large advantage over decades. In practice, an ETF is an index fund listed on the exchange. This is educational information, not investment advice.

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How an index fund works

The fund buys stocks (or bonds) in the same proportions as they appear in the index. If Apple constitutes 7% of the S&P 500 index, the index fund holds 7% of its portfolio in Apple.

There's no manager making subjective decisions. An algorithm automatically maintains the portfolio composition according to the index.

Index fund vs ETF

In practice, ETF is an index fund listed on the stock exchange. In Poland, the term "index fund" often covers both.

Why index funds win

SPIVA (S&P Indices Versus Active) studies show that after 15 years, 85–95% of actively managed funds lose to their benchmark. Main reason: high management fees (1.5–3% annually in Poland) eat up profits.

An index fund with 0.1% fee vs active fund with 2% fee — with the same gross return rate, the difference after 30 years is several dozen percent of portfolio value.

Popular index funds available in Poland

How Freenance can help

Freenance automatically tracks the value of your index funds:

• Portfolio value updated daily
• Rate of return including deposits and withdrawals (TWR and MWR)
• Asset allocation — what percentage of the portfolio are index funds
• FIRE projection based on historical rates of return

👉 Track your investments with Freenance — freenance.io

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FAQ

What is the difference between an index fund and an ETF?

Both replicate an index, but an ETF trades on an exchange throughout the day at market prices, while a traditional index fund is bought and sold once a day at the net asset value (NAV). ETFs typically have lower fees and a lower entry threshold equal to the price of one unit.

How is an index fund different from a mutual fund?

A classic mutual fund is usually actively managed — a manager picks securities trying to beat the market. An index fund is passively managed and simply mirrors the composition of a chosen index, which translates into lower fees and predictable behaviour relative to the benchmark.

What does TER (Total Expense Ratio) mean for an index fund?

TER is the annual total cost of holding the fund, expressed as a percentage of assets. For index funds it usually ranges from 0.07% to 0.5% per year and is deducted automatically from the unit value, so you do not see it as a separate charge.

Can an index fund lose value?

Yes. An index fund replicates the index, so if the underlying market falls, the fund value falls as well. Past returns do not guarantee future results, and equity investing always carries the risk of capital loss.

Is an index fund a good choice for a beginner?

For investors with a long horizon and limited time to analyse markets, a broadly diversified index fund can be a sensible core of a portfolio thanks to its low costs and simplicity. However, the choice should match your goals, risk tolerance and overall financial situation, and is not investment advice.