One of the great things about mutual funds is, unlike a portfolio of individual stocks, they don't require a great deal of management. Either the fund is doing well or it isn't. If the total return of the fund exceeds its costs, that's a good first step. One of the reasons mutual funds have fees associated with them is that they offset the cost of the management required to keep the fund's performance strong.

But sometimes even mutual funds can become too complicated for some investors. Sector funds are a good example. Sector fund performance can be negatively affected by a variety of factors even if the overall market is doing quite well. Thus was the need for a way to build a category of fund that just "follows the market."

An index is simply a list of certain investments. One of the best known is the Dow Jones Industrial Index, which is a list of 30 top U.S. companies. There are a number of other indexes, such as the Standard and Poor's 500 (S&P 500), which is an index of the top 500 U.S. companies by market capitalization, and the NASDAQ 100, including the top 100 stocks traded on the NASDAQ exchange.

An Index Fund simply buys all the stocks in a given index and holds them. This fixes the fund's returns very close to the performance of the stocks in that index, less any costs or fees. There are funds, for example, that buy the S&P 500 stocks only, making them an S&P 500 Index Fund. If the stocks in that index do well, that index fund does well.