Index funds are a way of gaining exposure to an investment market. Most investment markets have an index that measures their value over time. There is an index that covers almost every industry sector and asset class, including Australian and international shares, property, bonds and cash.
Rather than trying to guess which investments will outperform in the future, index managers replicate a particular market or sector. This means they invest in all or most of the securities in the index.
Indexing is based on the theory that investors as a group cannot beat the market - because they are the market. In fact, when you take costs into account Vanguard founder John C Bogle says investors as a group must underperform the market.
This is why when you look at the performance tables at any point in time there are always winners and losers. Picking consistent outperformers is almost impossible, so indexing provides a way of accessing market performance without the high costs.