What are Index Funds and How Do They Fit Into Your Portfolio? July 2, 2025

Index funds have been widely praised for their ability to generate steady returns with less risk and broader diversification than direct stock investments. When investors invest in individual company stocks, a single underperforming company can affect the return of their whole portfolio. In contrast, index funds mimic market indexes like the Dow Jones Industrial Average and S&P 500 index, and lessen the effect of any one company’s poor performance through diversification.

In addition, they also tend to charge lower fees than actively managed funds, contributing to their growing popularity. In fact, index funds now capture approximately 53% of the US market share.

What are Index Funds?

Index funds are a type of unit trust designed to replicate the performance of a specific market index. Like all unit trusts, they pool money from investors and invest in a diversified mix of stocks, bonds, and other securities.

What sets index funds apart is their passive investment strategy. They aim to mirror the composition and performance of an index by holding the same stocks in the same proportion. These funds may periodically rebalance to align with changes in the index’s composition

Passive Investing vs Active Investing

When it comes to investment strategies, two main approaches you’ll encounter are active investing and passive investing.

Passive investing, which involves tracking a market index, seeks to equal the market’s returns rather than outperform them. As there is little trading activity, this approach keeps costs low and removes the need for frequent decision making or timing the market.

Active investing, on the other hand, entails individual investors or professional fund managers actively choosing companies they believe will beat the market. While there’s potential for higher returns, this strategy also comes with larger expenses and risks and needs ongoing research and market timing.

Parameter	Active Investing	Passive Investing
Investment Goal	Tries to outperform the market	Matches the market return
Strategy	Relies on the decisions by fund managers	Tracks a market index (S&P 500, Dow Jones)
Techniques	Picks stocks	Replicates the composition of an index
Returns	Generates potentially higher returns, but incurs higher losses	Generates market returns with lower volatility
Management	Requires research and expertise as you manage it actively	Requires less management
Expense ratio	Typically higher	Typically lower
Charges/Cost	Higher (0.5% – 2%)	Lower (0.02% – 0.2%)
Tax Efficiency	Less tax efficient	More tax efficient

Pros and Cons of Index Funds

As with any other investment instrument, index funds have their risks and rewards. Here’s a balanced look at both:

Benefits of Index Funds

Reduced Risk through Diversification: A single investment gives you exposure to hundreds of companies, spreading risk across sectors and industries
Lower Costs: Even though a professional fund manager supervises an index fund, with no need for active management the expense ratios are lower
Less Human Bias and Mistakes: Index funds follow predefined strategies and mirrors indices, this minimises the impact of emotional decision making or poor judgment
Transparency: Since they mirror a market index, the holdings of an index fund are well-known and accessible on practically any investment platform
Tax Benefits: Index funds tend not to sell frequently since they’re merely mirroring an index, and thus have lesser taxable events
Historical performance: Over the long run, several index funds have outperformed their actively managed counterparts, particularly after accounting for fees and expenditures

Drawbacks of Index Funds

Average Market Returns: Since they may include both high and low performers, returns reflect the market average not above it
Costs to Manage the Index Fund: Although fees are lower, they are not zero. High-cost index funds can erode returns.
Possible Tracking Errors: Occasionally, the fund isn’t in lockstep with its target index. This mismatch is termed tracking error. If the tracking error is minimal, the fund returns and the returns of the index being tracked (the benchmark) would be the same. The tracking error of a fund is usually stated in the factsheet
No Downside Protection: In a market downturn, index fund continue holding all the stock in the index, even the underperformers
No Control over Holdings: Investors have no say over the composition of the fund, which might include companies they would not otherwise choose.

ETF vs Index Fund

Index funds are offered as ETFs (Exchange-Traded Funds) or unit trusts. While ETFs provide lower costs and stock-like flexibility, unit trusts follow market indexes. Besides unit funds, you must also know the difference between ETF vs index funds to make the right investment decision:

Parameter	Exchange Traded Fund (ETF)	Index-Tracking Unit Trust Fund
How It Works	Traded on SGX or other exchanges like a stock	Pooled investment bought directly from the fund house
Pricing	Real-time pricing throughout trading hours	Priced once a day at NAV (Net Asset Value)
Trading Flexibility	Buy/sell anytime during market hours	Buy/sell at end-of-day NAV
Minimum Investment	From 1 share	Can start from S$1
Fees/Expense Ratio	Lower (typically 0.05% – 0.5%)	Higher (typically 0.5% – 1.5%) + potential sales charge
Liquidity	Higher – traded in real-time in the market	Lower – holdings are redeemed with the fund house
Dividends	Paid out or reinvested (depending on ETF)	Paid out or reinvested

Index Funds Available on POEMS

		Minimum investment (differs for CPF fund source)
Amundi Prime USA Fund	Solactive GBS United States Large and Mid Cap Index	S$1
Amundi Index MSCI World A12S (C) SGD	MSCI World Index	S$1
Amundi Index MSCI Emerging Markets A12S (C) SGD	MSCI Emerging Markets Index	S$1
Amundi Index Global Aggregate Bond A12HS (C) SGD	Bloomberg Global Aggregate SGD Hedged Index	S$1
Infinity U.S. 500 Stock Index Fund	S&P 500 Composite Stock Price Index	S$1

Conclusion

Building an investment portfolio on your own that yields successful returns can feel challenging. Looking for the right investment usually involves a lot of research into a company’s business model and financials. One way to bypass it all and make it more manageable is investing passively in index funds.

Some experts now believe that index funds can top 70% of total unit trust assets within this decade. Choose an index fund now and empower your investment goals.

FAQs about What are Index Funds

Why are index funds considered a low-cost investing option?

Index funds are managed passively, meaning they replicate the performance of a market index rather than striving to beat it. This decreases the need for active management, which cuts costs like management and operational expenditures.

What are low cost index funds?

Low-cost index funds are funds with reduced expense ratios, making them more affordable and accessible for investors. These funds keep expenses low by utilising a passive management method and concentrating on broad market indexes.

How do index funds differ from actively managed funds?

Index funds strive to match the performance of an index and are passively managed, whereas actively managed funds include fund managers choosing equities to try to beat the market.

What are the benefits of index funds investment?

Index funds offer diversity, low-cost ratios, and predictable long-term returns. They are suitable for investors wanting a hands-off, cost-effective strategy to generate wealth over time.

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About the author

Darius Lee

Darius Lee graduated from the National University of Singapore with a Bachelor’s of Engineering degree. Life took him on a different path and he ended up spending 8 years in the Wealth Management space. He is as obsessed with the technical aspects of investing as well as the psychology that drives investors. In his free time, he enjoys reading about topics from Economics to Science Fiction.

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