What are Indices, Index Funds, Mutual Funds, and Exchange Traded Funds (ETFs)?

Index:

At its core, an index is a set of investments and a function computing their weights. The set of investments could include stocks, bonds, real estate, crypto etc.

Weighting:

The weighting function often falls under certain categories but can be any arbitrary function. You can create an index that includes only stocks that start with the letter A with a weighting that corresponds to the height of its CEO. The most common one in the stock market is market-cap weighting. The following examples of weighting functions are specifically for stock market indices.

Weighting: Market Capitalization:

This means weighting each stock proportional to its market capitalization. A 1 trillion dollar company will be weighted 1000x more than a company worth 1 billion dollars. This type of index has the best performance assuming the efficient market hypothesis. Examples include the S&P 500 and Russel 2000.

Weighting: Price:

Each stock is weighted proportional to its share price. A company with a share price of $50 will be weighed 2x more than a company with a share price of $25. An example is the Dow Jones Industrial Average.

Weighting: Equal:

An equal weighting would mean every company in the index is equally weighted. An example is the S&P 500 Equal Weight Index.

Index Fund:

An index fund is any fund that replicates a certain index. You can’t invest in the S&P 500 because that’s simply an index, but there are funds that intend to mimic the behavior of the S&P 500. Investors can use it to track a certain index instead of making trades on all of those investments individually.

Mutual Fund:

A managed pool of money that could be either passively or actively managed. They can include a minimum investment, but investors can often specify any arbitrary amount to invest. These funds can’t be actively traded in the market and buy/sell orders will occur at the end of the trading day when prices are calculated. An example is Fidelity’s FXAIX.

Exchange Traded Fund (ETF):

A fund that’s split up into shares that can be actively traded on the stock market. If they track an index, they don’t calculate the prices themselves, instead, they rely on market efficiency with the assumption that their share price will correlate with the index since the fund buys/sells investments according to the index. A popular fund is State Street’s SPDR S&P 500 ETF with ticker SPY or Vanguard’s VOO.