What Is a Broad Market Index Fund?
Definition & Examples of Broad Market Index Funds
A broad market index fund is a mutual fund that constructs its portfolio to track a large underlying index. If you're investing on your own or working with an advisor who is suggesting one of these funds, it helps to understand how these funds work and what they try to accomplish.
Learn what broad market index funds are, how fund managers design them, and some advantages and disadvantages.
What Are Broad Market Index Funds?
An index fund is a basket of investments, such as stocks and bonds, that allows an investor to purchase multiple investment types in one transaction. The managers distribute the invested capital per the fund's guidelines and then passively manage the fund, only making changes to the portfolio when the indexes change.
How Do Broad Market Index Funds Work?
Broad market index funds invest in a large segment of the investment market, generally targeting securities listed on one of the many indexes. Some common indexes that funds follow are the Standard & Poor's 500, the Dow Jones Industrial Average, and the Nasdaq Composite.
There are close to 5,000 indexes in the U.S. Some indexes, such as the Wilshire 5000 and Russell 3000, track thousands of publicly owned companies' stocks.
Market exposure is a term investors use to describe how much they have invested in a sector. If an investor has a broad market exposure, it means they invest in multiple sectors. Investing across various sectors is one diversification method investors use to reduce risk.
The funds that offer the broadest market exposure to investors are often called total market index funds. A mutual fund or exchange-traded fund (ETF) that tracks the S&P 500 Index is a broadly diversified index fund, but a fund that follows it is not broad enough to be considered a broad index fund.
Broad market funds invest in a more extensive index, such as the Wilshire 5000 or Russell 3000. The Wilshire 5000 and Russell 3000 include most of the domestic U.S. stocks traded on stock exchanges. This wide berth of holdings is why a fund's name usually has "total market" included, such as the Vanguard Total Market Index Fund Admiral Shares.
Broad market index funds that invest in bonds often track the Bloomberg Barclay's US Aggregate Bond Index, which consists of approximately 8,000 bonds, hence the name "total bond index" for those index funds that track it.
Advantages and Disadvantages of Broad Market Index Funds
Lack of flexibility
Lower gains than managed funds
Tracks indexes, but never beats them
Broad market index funds have the same advantages that other index funds offer, with a few extra. Here are the primary benefits for investors:
Like most other index funds, broad market index funds have expense ratios lower than 0.20%, which is $20 for every $10,000 invested. Low expenses help boost returns, especially in the long run, because fewer fees equal more money compounding over time.
A primary reason for the low expenses of index funds is that the holdings are not sold and replaced—called turnover—at a high rate. Many actively managed funds (non-index funds) can have turnover higher than 50%, whereas index funds usually turnover less than 5%.
Most index funds are diversified, meaning that they invest in a large number of securities. However, broad market index funds offer greater diversity, meaning that they invest in a larger number of securities than less broad index funds.
Non-indexed, actively managed funds might perform better year-to-year than passively managed indexed funds, but because of volatility, might perform worse in the long run.
Like other index funds, broad market index funds are passively managed, which means that the manager is not actively trying to beat the benchmark index. Instead, they are attempting to track the benchmark's performance, which removes some risk for investors.
Low turnover reduces taxes passed through to the investor. When mutual funds sell holdings at a price higher than the purchase price, it produces capital gains. Capital gains trigger capital gains taxes—less turnover prevents extra taxation caused by higher turnover.
Since broad market funds are similar to index funds, they have many of the same disadvantages.
Lack of Flexibility
Fund managers follow the fund's guidelines, so they end up with less flexibility than an actively managed mutual fund might have. Buying into a broad market index fund locks your capital into the investments the manager is required to track, so if prices start to fall, you'll have to ride it out and hope for the best.
For investors, returns will be lower than they would in an actively managed fund since the fund managers can't switch lower-performing funds out.
They Can't Beat the Indexes
Funds that track indexes follow the index; returns on passively managed index funds generally trail their underlying indexes.
- Broad market index funds give investors a wide market exposure.
- Leading advantages are lower risk and costs to investors.
- Broad market index funds are less flexible than mutual funds or other actively managed funds.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.