Index Funds and ETFs Explained: How S&P 500 and Nasdaq-100 Funds Work

What is an index fund?

An index is a list of securities chosen by a set of rules, used to measure a market. An index fund is a fund that tries to copy that list. In the SEC's definition, an index fund is a mutual fund, exchange-traded fund (ETF) or unit investment trust that follows a passive investment strategy designed to achieve approximately the same return as a particular index before fees ^[13].

Index funds take different approaches. Some buy every security in the index; others buy only a representative sample, and some also use derivatives such as futures ^[1]. Because the manager is not picking securities, an index fund does not need a team of research analysts, which can mean lower costs, but the SEC cautions that not all index funds are cheaper than actively managed funds ^[1].

How are indices weighted?

Many indices weight each company by market capitalisation, the share price times the number of shares outstanding, so larger companies count for more ^[1]. Some, such as the Dow Jones Industrial Average, are price-weighted instead ^[1]. Weighting matters because it decides how much of each dollar invested goes into each company.

This guide is general information about how these funds work. It is not financial advice and does not recommend any fund or provider.

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

Both pool money from many investors and invest it in a portfolio, and both can track an index ^[2][3]. The main difference is how you buy and sell.

• Mutual funds are bought from and sold back to the fund itself, at the next calculated net asset value (NAV), on any business day, minus any redemption fees ^[3].
• ETFs are bought and sold on national securities exchanges at market prices whenever the market is open ^[2]. An ETF must register with the SEC as an open-end investment company or a unit investment trust ^[2].

Because an ETF trades on an exchange, its market price can differ slightly from the value of its holdings. On 2 November 2026, for example, the SPDR S&P 500 ETF Trust (SPY) had a NAV of $751.77 and a closing price of $752.10 ^[5]. The SEC also notes that because many ETFs exchange portfolio securities in kind rather than for cash, they typically make fewer capital gains distributions, and so trigger lower taxes, than mutual funds ^[2]. Reinvesting ETF dividends can be more complicated and may involve brokerage commissions ^[2].

What are the S&P 500 and the Nasdaq-100?

S&P 500

The S&P 500 is designed to measure the performance of the large-cap segment of the US equity market, holds companies across all eleven GICS sectors, and is float-adjusted market capitalisation weighted ^[5]. 'Float-adjusted' means only shares available for public trading are counted. On 2 November 2026 the SPY fund page listed 503 index holdings and 504 fund holdings ^[5]; the count exceeds 500 because some companies, such as Alphabet, have more than one share class in the index ^[5].

Membership changes as companies grow, shrink or merge. On 30 October 2026, S&P Dow Jones Indices announced that Okta was set to join the S&P 500 ^[10]. Funds that track the index then adjust their holdings to match.

Nasdaq-100

The Nasdaq-100 is designed to measure the performance of 100 of the largest Nasdaq-listed non-financial companies and uses a modified market capitalisation weighting ^[8]. It does not include financial companies, including investment companies ^[9]. Its index page listed 101 components on 3 November 2026, again because of multiple share classes ^[9]. The index is reconstituted each December ^[8].

The 'modified' weighting adds caps. In the annual weighting step, when a company's initial weight is above 24%, the methodology describes adjusting weights so that no company exceeds 20%, and, when companies weighing more than 4.5% together reach 48% or more, bringing their combined weight down to 40% ^[8]. The S&P 500 is broader across sectors; the Nasdaq-100 excludes financials, which makes the two indices behave differently.

How concentrated are S&P 500 index funds in 2026?

Market-cap weighting means a fund owns most of whatever has grown largest. On 2 November 2026 the ten biggest holdings of SPY were Apple (7.60%), NVIDIA (7.52%), Microsoft (5.79%), Amazon.com (3.71%), Alphabet Class A (2.52%), Broadcom (2.36%), Meta Platforms Class A (2.06%), Alphabet Class C (2.03%), Tesla (1.75%) and Eli Lilly (1.74%) ^[5]. Those weights add up to 37.08%, so a fund holding about 500 companies had more than a third of its money in ten positions (this guide's sum of the published weights).

Concentration cuts both ways. When the largest companies rise, the fund benefits; when they fall, they pull the whole index down. A buyer of an S&P 500 fund and a separate technology fund may own the same companies twice. The SEC notes that an index fund is subject to the same general risks as the securities in its index ^[1].

What do index funds and ETFs cost?

Funds deduct their running costs from NAV, so investors pay them indirectly ^[2]. The expense ratio is the yearly cost as a share of the investment. Even small differences matter over time, because a fund with higher costs must perform better to deliver the same return ^[2].

The SEC illustrates this with a $100,000 portfolio growing 4% a year for 20 years: with a 0.25% annual fee it ends near $208,000, with 0.50% near $198,000, and with 1.00% near $179,000 ^[4].

Funds tracking the same index can charge different fees. SPY's gross expense ratio is 0.0945% ^[5], the iShares Core S&P 500 ETF (IVV) charges 0.03% ^[6], and Invesco QQQ, which tracks the Nasdaq-100, has a total expense ratio of 0.18% ^[7]. On $10,000 held for a year, those rates equal about $9.45, $3 and $18 (this guide's arithmetic). Scale is large: on 2 November 2026 SPY had $797,954.75 million under management and IVV $867,098,495,687 in net assets ^[5][6]. Brokerage commissions, bid-ask spreads and taxes come on top and vary by account.

Do index funds beat actively managed funds?

Active managers try to beat an index by choosing investments; the SEC notes that their performance is heavily dependent on the manager's skill ^[2]. S&P Dow Jones Indices measures the results in its SPIVA scorecards. In its Mid-Year 2026 report, published on 17 September 2026, 67% of all active large-cap US equity funds underperformed the S&P 500 in the first half of 2026, an improvement from 79% over full-year 2025 ^[11]. The same report found 74% of mid-cap and 69% of small-cap funds underperformed their benchmarks ^[11].

Results vary by category and period: in the same report, only 49% of US-domiciled international funds and 38% of emerging-market funds underperformed their benchmarks ^[11]. Underperformance figures compare funds with an index that has no costs, while an index fund also pays fees and may not track its index perfectly ^[1]. Past results do not predict future returns ^[3].

What are the benefits and risks of index funds?

Benefits the SEC describes

• Passive management usually means less trading, lower transaction costs, lower realised capital gains and lower fees than actively managed funds ^[13].
• Diversification across many companies lowers the damage if one company fails, though some funds are far less diversified than others ^[2].
• Low minimum investments and daily liquidity ^[2][3].

Risks the SEC lists

• Market risk: the fund carries the same general risks as the securities in its index ^[1].
• Lack of flexibility: an index fund may be less able to react to falling prices ^[1].
• Tracking error: a fund may not perfectly track its index, for example if it holds only a sample ^[1].
• Underperformance: fees, trading costs and tracking error can leave a fund behind its index ^[1].
• No guarantee: ETFs and mutual funds are not guaranteed or insured by the FDIC or any other government agency, and investors can lose some or all of their money ^[2][3].

How do you evaluate an index fund before investing?

1. Identify the index. Read how the index is built; the SEC suggests asking how the makeup of the fund's index is determined ^[1].
2. Read the prospectus and shareholder report. These list fees, risks and holdings, and are available on fund websites and on the SEC's EDGAR system ^[1].
3. Compare total costs. Check the expense ratio and any sales or redemption fees; the SEC's example shows how fees compound ^[4].
4. Check concentration. Look at the top ten holdings and sector weights, as in the SPY data above ^[5].
5. For ETFs, check the market price against NAV. Fund pages publish both, and some also show the premium or discount ^[5][6].
6. Match the fund to the goal. The SEC suggests asking how the fund's strategy fits your goals ^[1]; that is a personal decision.

A note for readers in Iran

US sanctions rules prohibit US persons from exporting services to Iran, including services whose benefit is received in Iran ^[12]. A fund account or brokerage service provided by a US firm to a person in Iran would be such a service, so it is prohibited unless authorised under those rules ^[12]. This is general information, not legal advice.