Passively managed index funds. Definition, How They Work & Examples
13 Min read | Invest
What Are Passively Managed Index Funds?
Passively managed index funds are investment vehicles designed to track specific market benchmarks, like the S&P 500 or Total Stock Market Index, by holding the same securities in the same proportions as their underlying index.
Instead of portfolio managers hand-picking stocks to beat the market, these funds use algorithms to replicate index performance as closely as possible. The primary objective is market matching, not market beating.
This approach was revolutionary when John C. Bogle introduced it in 1976 through Vanguard. Critics initially called it "Bogle's Folly", arguing that settling for average returns was un-American. Fast-forward to August 2025, and passive funds have surpassed active funds in the U.S. assets for the first time, holding $18.0 trillion versus $16.87 trillion.
This article explains how these funds work, how you make money from them, when you can buy and sell, minimum investments required, and the best options available for 2026.
Key Facts About Passively Managed Index Funds
Average expense ratio for passive funds is just 0.05% compared to 0.40% for actively managed funds, saving investors thousands over decades
Only 13.2% of active funds beat the S&P 500 in 2024, according to SPIVA data, demonstrating the difficulty of outperforming the market
Passive funds now hold $18.0 trillion in U.S. assets, representing 51.6% of the total market as of August 2025 (beating the active funds for the first time in history)
Warren Buffett recommends a 90% allocation to low-cost S&P 500 index funds and 10% to short-term government bonds for most investors
Index funds have saved investors approximately $503 billion in fees since 2000 compared to what they would have paid in active funds
Zero-expense options are now available, including Fidelity FNILX and FZROX with 0% expense ratios
The S&P 500 has averaged 12.21% annual returns over the past 10 years (2015-2024), significantly outpacing inflation
Recommended minimum investment period is 7+ years, ideally 10-15 years, to ride out market volatility and maximize compound growth
Index funds are significantly more tax-efficient due to lower portfolio turnover, typically under 5% annually versus 60-100% for active funds
You can buy or sell mutual fund index funds once daily after market close, while ETF index funds trade continuously during market hours like stocks
How Do You Make Money With Passively Managed Index Funds?
You earn returns from passively managed index funds through three primary mechanisms:
- First, price appreciation occurs when the underlying securities in the index increase in value, causing the fund's share price to rise proportionally. If the S&P 500 grows 10% in a year, your S&P 500 index fund grows approximately 10% (minus minimal fees).
- Second, dividend income is generated when companies in the index pay dividends. The fund collects these payments and distributes them to shareholders, typically quarterly. These dividends are taxed as ordinary income unless held in tax-advantaged accounts like 401(k)s or IRAs.
- Third, capital gains distributions happen when securities within the fund are sold at a profit. This is rare in index funds due to their buy-and-hold nature and low turnover, but when it occurs, realized gains are distributed annually to shareholders.
Tax treatment matters significantly: long-term capital gains (holdings over one year) are taxed at favorable rates of 0%, 15%, or 20% depending on your income bracket, while short-term gains face ordinary income tax rates up to 37%.
You can choose to reinvest dividends automatically to accelerate compound growth or receive them as cash. Here's a concrete example how this works: if you invest $10,000 in an S&P 500 index fund and the index returns 10% annually, you'd have approximately $25,937 after 10 years before taxes.
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When Can You Buy and Sell Passively Managed Index Funds?
The trading mechanics differ significantly between mutual fund and ETF index funds.
For mutual fund index funds:
- They trade once daily at the net asset value (NAV) calculated after market close at 4:00 p.m. ET, typically posted by 6:00 p.m. ET.
- Any buy or sell order you place during the trading day executes at that day's closing NAV.
- There are no intraday price fluctuations for mutual funds.
- Everyone gets the same price regardless of when during the day they submit their order.
- This simplicity appeals to long-term investors who aren't concerned with minute-by-minute price movements.
For ETF index funds:
- They trade continuously throughout regular market hours (9:30 a.m. to 4:00 p.m. ET) and extended trading sessions, with real-time price fluctuations based on supply and demand.
- You can place market orders, limit orders, stop-loss orders, and other advanced order types just like individual stocks.
- There are no required holding periods for index funds.
- You can sell anytime without penalties, unlike CDs or certain retirement accounts.
- However, some brokerages charge short-term trading fees (typically $25-50) if you sell within 30 days of purchase to discourage market timing.
The recommended approach treats index funds as long-term investments with a minimum 7-year horizon, ideally 10-15 years, to ride out market volatility and maximize compounding.
Minimum Amount to Invest in Passively Managed Index Funds
Minimum investment requirements vary by fund type and provider, but accessibility has improved dramatically in recent years.
Traditional index mutual funds typically require minimums ranging from $500 to $3,000, though several major providers now offer $0 minimum options. Herea re some real-life examples:
- Vanguard index mutual funds require $3,000 minimum for Admiral Shares (which have lower expense ratios) or $1,000 for Investor Shares.
- Fidelity's popular funds like FXAIX (S&P 500) and FSKAX (Total Market) have $0 minimums, making them accessible to virtually any investor.
- Schwab's index funds also have $0 minimums across their lineup.
ETF index funds have no traditional minimum investment requirement, but you must purchase at least one full share.
Depending on the specific ETF, this might cost $100-500 per share. For example, Vanguard's VOO (S&P 500 ETF) trades around $400-500 per share.
The good news is that many brokerages now offer fractional ETF shares, allowing investments starting at just $1-5. TradeStation, eToro, and Robinhood all provide fractional share investing.
Best Passively Managed Index Funds in The Last 10 Years
Looking at the past decade of performance helps identify which passively managed index funds have delivered exceptional returns for investors. These funds have demonstrated strong tracking accuracy, low costs, and consistent performance through various market conditions.
Here are the top performers:
Vanguard Information Technology ETF (VGT) has delivered outstanding 10-year annualized returns of approximately 21.5% with an expense ratio of just 0.10%.
This fund tracks the MSCI US Investable Market Information Technology 25/50 Index, holding tech giants like Apple, Microsoft, and Nvidia.
With $82 billion in assets under management and no minimum investment for ETF shares, we chose it for investors seeking concentrated exposure to the technology sector that has dominated market returns.
The fund holds 318 stocks, providing diversification within the tech space.
Vanguard S&P 500 ETF (VOO) has achieved 10-year annualized returns of approximately 13.1% with an ultra-low 0.03% expense ratio.
Tracking the S&P 500 index with $576 billion in AUM, this fund represents the 500 largest U.S. companies.
No minimum investment is required with fractional shares available at major brokerages.
We chose it as the gold standard for core U.S. equity exposure, offering broad diversification across all sectors with minimal cost drag.
Vanguard Total Stock Market ETF (VTI) delivered 10-year annualized returns of approximately 12.8% with a 0.03% expense ratio.
This fund tracks the CRSP US Total Market Index, holding over 3,600 stocks across all market capitalizations.
With $2 trillion in AUM and no minimum investment, we selected it for investors wanting complete U.S. market exposure, including small and mid-cap stocks that VOO excludes.
iShares Core S&P 500 ETF (IVV) has produced 10-year annualized returns of approximately 13.0% with a 0.03% expense ratio.
Nearly identical to VOO in holdings and performance, this BlackRock fund manages $634 billion in assets.
We chose it as an excellent alternative to Vanguard's offerings, particularly for investors who prefer BlackRock's platform or already hold other iShares products.
Schwab U.S. Large-Cap ETF (SCHX) achieved 10-year annualized returns of approximately 12.9% with an incredibly low 0.03% expense ratio.
Tracking the Dow Jones U.S. Large-Cap Total Stock Market Index, this fund holds approximately 750 large-cap stocks with $58 billion in AUM.
We chose it for Schwab clients seeking slightly broader large-cap exposure than the S&P 500 while maintaining rock-bottom costs.
Fidelity 500 Index Fund (FXAIX) delivered 10-year annualized returns of approximately 13.0% with a 0.015% expense ratio, one of the lowest available.
This mutual fund tracks the S&P 500 with $696 billion in AUM and requires $0 minimum investment.
We selected it as the best mutual fund option for investors who prefer mutual fund mechanics over ETFs and want the absolute lowest expense ratio available.
Vanguard Growth ETF (VUG) has achieved 10-year annualized returns of approximately 16.8% with a 0.04% expense ratio.
This fund tracks the CRSP US Large Cap Growth Index, focusing on growth-oriented companies with strong earnings momentum.
With $147 billion in AUM, we chose it for investors seeking higher growth potential and willing to accept slightly higher volatility than broad market funds.
Best Passively Managed Index Funds to Follow in 2026
Looking ahead to 2026, these passively managed index funds stand out for their combination of rock-bottom costs, strong performance, massive assets under management, and accessibility to investors of all levels.
Fidelity 500 Index Fund (FXAIX) charges an industry-leading 0.015% expense ratio with $696 billion in AUM and $0 minimum investment.
This mutual fund tracks the S&P 500 with exceptional accuracy, typically within 2 basis points of the index.
We're following it in 2026 because Fidelity continues to lead the race to zero fees while maintaining excellent fund management.
The combination of no minimum, rock-bottom costs, and Fidelity's robust platform makes it ideal for investors at any level.
Vanguard S&P 500 ETF (VOO) maintains a 0.03% expense ratio with 16.5% five-year annualized returns and $576 billion in AUM.
Fractional shares are available with $0 minimum at most major brokerages (e.g.: TradeStation, eToro).
We're watching this fund because it remains the benchmark against which all other S&P 500 funds are measured.
Vanguard's ownership structure (owned by fund shareholders) ensures fee reductions continue benefiting investors rather than corporate profits.
Schwab S&P 500 Index Fund (SWPPX) offers a 0.02% expense ratio with $0 minimum investment and $91 billion in AUM.
This mutual fund provides S&P 500 exposure at costs nearly as low as Fidelity's offering.
We're following it in 2026 because Schwab's integrated banking and brokerage platform offers unique convenience for investors who want their checking, savings, and investments in one place.
Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX) manages over $2 trillion in assets with an 8.2% return in Q3 2025 and a 0.04% expense ratio.
The $3,000 minimum is higher than competitors, but the fund's comprehensive exposure to over 3,600 U.S. stocks across all market caps is unmatched.
We're following it because it represents true total market diversification, capturing small and mid-cap growth that S&P 500 funds miss.
Fidelity ZERO Total Market Index Fund (FZROX) charges an unprecedented 0% expense ratio with $0 minimum investment.
This proprietary Fidelity fund tracks a custom total market index with over 2,400 holdings.
We're following it because zero-fee funds represent the ultimate evolution of index investing.
The trade-off is you can't transfer this fund to another brokerage, but for long-term Fidelity customers, the cost savings are unbeatable.
Fidelity ZERO Large Cap Index Fund (FNILX) also charges 0% with $0 minimum, tracking approximately 500 large-cap U.S. stocks similar to the S&P 500.
We're watching this fund in 2026 because it demonstrates that large-cap index investing can literally be free.
Combined with Fidelity's excellent customer service and platform, it's hard to beat for cost-conscious investors.
Vanguard Total International Stock ETF (VXUS) provides exposure to over 8,000 non-U.S. stocks with a 0.08% expense ratio and $80 billion in AUM.
We're following it in 2026 because diversification beyond U.S. borders remains important despite America's market dominance.
International stocks are currently trading at lower valuations than U.S. stocks, potentially offering better forward returns.
Frequently Asked Questions About Passively Managed Index Funds
What is the required holding period for passively managed index funds?
There is no required holding period for passively managed index funds. You can sell anytime without penalties or restrictions.
However, financial experts strongly recommend holding index funds for a minimum of 7 years, ideally 10-15 years or longer, to ride out market volatility and maximize compound growth.
Some brokerages charge short-term trading fees (typically $25-50) if you sell within 30 days of purchase to discourage excessive trading.
Are passively managed index funds safe?
Passively managed index funds are significantly safer than individual stocks due to diversification across hundreds or thousands of securities, but they're still subject to market risk.
You could lose money in market downturns. For example, the S&P 500 fell approximately 37% during the 2008 financial crisis, though it recovered and exceeded previous highs within a few years.
Complete loss of your investment is virtually impossible because an S&P 500 fund would require all 500 companies to become worthless simultaneously.
Index funds are best suited for long-term goals like retirement, not emergency funds or money you'll need within the next few years.
How do index funds pay dividends?
Index funds collect dividends from the underlying companies in the index and distribute them to shareholders, typically on a quarterly basis.
These dividend distributions are taxed as ordinary income unless your index funds are held in tax-advantaged accounts like 401(k)s, IRAs, or Roth IRAs.
Dividend yields for S&P 500 index funds typically range from 1.5% to 2.0% annually.
You have two options when receiving dividends:
- You can choose to reinvest them automatically to purchase additional fund shares (accelerating compound growth)
- You can receive them as cash deposited into your brokerage account.
Most long-term investors choose automatic reinvestment to maximize compounding. The dividends you receive are proportional to the number of shares you own, and the fund company handles all the collection and distribution logistics automatically.
Can I lose all my money invested in a passive index fund?
Losing all your money in a broad market index fund is highly unlikely, bordering on impossible. An S&P 500 index fund would require all 500 of America's largest companies to become worthless simultaneously, which has never happened and would represent a complete collapse of the U.S. economy.
However, you can lose substantial value in severe market downturns. The S&P 500 fell approximately 37% in 2008, 49% from 2000-2002, and 34% in 2020 (though it recovered quickly).
These temporary declines are very different from permanent loss. Investors who held through these downturns and continued investing saw their portfolios recover and reach new highs.
What's the difference between index mutual funds and index ETFs?
Index mutual funds and index ETFs track the same indexes and offer similar returns, but they trade differently:
- Mutual funds trade once daily after market close at the net asset value (NAV), with orders placed anytime during the day executing at that day's closing price.
- Index ETFs trade continuously during market hours like stocks, with real-time pricing and the ability to use market orders, limit orders, and stop-loss orders
- Mutual funds often have investment minimums ranging from $500 to $3,000 (though Fidelity and Schwab offer $0 minimums), while ETFs have no minimums if you can buy fractional shares.
- Both types have similar expense ratios, typically 0.03% to 0.05% for S&P 500 funds.
- ETFs may be slightly more tax-efficient due to their unique creation and redemption mechanism, though index funds of both types have very low turnover.
- For long-term buy-and-hold investors, the differences are minimal. Choose based on your preference for trading flexibility (ETFs) or simplicity (mutual funds).
Do I need a financial advisor to invest in index funds?
No, you don't need a financial advisor to invest in index funds successfully. Index fund investing is simple enough for DIY investors to handle independently.
The basic process involves opening a brokerage account at a major provider, choosing a low-cost S&P 500 or total market index fund, and investing consistently over time.
Warren Buffett's recommended portfolio of 90% S&P 500 index fund and 10% short-term government bonds requires no professional management. You can set up automatic monthly investments and dividend reinvestment in about 10 minutes.
Financial advisors typically charge 1% of assets annually, which significantly reduces your returns over decades.
Conclusion: Start Investing in Passively Managed Index Funds Today
Passively managed index funds offer the best combination of:
- Low costs - as low as 0% expense ratios
- Strong long-term performance - matching market returns that beat 87% of active managers
- Tax efficiency - saving thousands in taxes over decades
- Simplicity - no need to pick stocks or time markets
Warren Buffett's endorsement of index funds isn't just talk. He's directed that 90% of his estate be invested in a low-cost S&P 500 index fund.
The fact that passive funds now dominate the industry with over $18 trillion in assets reflects widespread recognition of their superiority over expensive, underperforming active management.
Getting started is straightforward:
- Open a brokerage account at a major provider like eToro, TradeStation, or Fidelity
- Choose a low-cost S&P 500 or total market index fund such as FXAIX, VOO, or SWPPX
- Start with whatever amount you can afford, whether that's $1 with fractional shares or $3,000 for Vanguard Admiral Shares
- Set up automatic monthly investments to dollar-cost average, which removes emotion from investing and helps you buy more shares when prices are low
- Reinvest dividends automatically to maximize compound growth
- Hold for the long term, with a minimum 7-year horizon and ideally 10-15 years or more
Index fund investing has helped millions of Americans build wealth for retirement, and the best time to start is now.
Even small, consistent investments of $100-200 monthly compound into significant wealth over decades. The combination of low costs, broad diversification, and patient long-term investing has proven to be one of the most reliable paths to financial security.
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