"Invest with rules, not intuition. Calculate. Don't speculate." - Mark Hebner

Definition:

Index funds are mutual funds with specific and clearly defined sets of rules of ownership. When stocks are within the rules of ownership, they are purchased and held. When they no longer meet the rules, they are sold.

For example, a Small Value Index Fund will have a clear set of rules that define small and value. However, those rules are not the same for all small value indexes. Vanguard (S&P 600 Barra Value), Dimensional Fund Advisors, Russell, and Wilshire all have small value indexes. However, each one of them has a different set of rules of ownership and therefore different risk and return characteristics. This is one reason IFA can assist you.

Index Fund Advantages:

The annual expenses and fees of index funds are one-tenth to one-third that of actively managed mutual funds.
Actively managed funds, when adjusted for risk, do not outperform the appropriate index by enough to cover the cost of their higher trading costs and taxes.
If a fund claims higher returns than an index, they took more risk, either through stock concentration or style drift.
Lower returns are the result of higher transaction costs and higher fees or lower risk.
Claims of higher returns are the result of inaccurate benchmarking, which is the measurment of risk. Also, many costs of actively managed funds are overlooked, such as loads and taxes.
Index fund managers don't buy and sell as often as managers of active funds, resulting in lower capital gains distributions and therefore lower taxes. Tax-managed index funds nearly eliminate all tax liability, due to dividend and capital gains management.

Comparison Table
 
Active Investing
Index Funds Investing
Return Objective Beat a market Obtain the market rate of returns for an index or asset class
Style Definition
One study indicates 40% drift from style classification. Actually 100% drift since they buy stocks other than what are in the index.
 Pure and consistent classification and risk exposure.
Individual Average Equity Investor Returns over 17 years 5.32% annualized S&P 500 = 16.29%
Approach Picking stocks, times, managers or styles. Buy and hold a globally diversified portfolio index funds
State of Mind Stressed Relaxed
Taxes and Portfolio Turnover High taxes of about 2.7% of assets (eating up about 20% of return over 10 years) Turnover averages about 70% Low taxes with tax-managed index funds of about 0.6% Turnover averages about 10%.
Net Performance Well below the index, by the amount of fees, expenses and taxes Very close to the index or asset class.
Individual Investors Currently about 98% of individual investors are active. Currently about 2% are indexers and growing rapidly, since 1999.
Institutional Investors Currently about 70% are active investors and rapidly declining. Currently about 30% are indexers and growing.
Proponents Virtually all Brokerage Firms, Mutual Fund Companies, Market Timing Services, Investment Press and Brokerage Training Programs. The Univ. of Chicago, Nobel Prize Recipients, Vanguard Group, Dimensional Fund Advisors, Barclays Global Investors and recently, Charles Schwab & Company
Analytical Techniques Art, Speculation, Qualitative, Disregard for Risk, Forecasting, Predicting the Future, Feelings, Intuition, Luck, Betting, Gambling, Like going to Las Vegas. Science - Quantitative, Risk Management, Long Term Statistical Analysis, Accurate Performance Measurements, Like Insurance Companies.
*DFA Equity Balanced: a Globally Diversified Portfolio of Index Funds All of the above will be substantiated throughout the 12-Step Program.

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