An “index fund” is a mutual fund or exchange-traded fund that tries to replicate the performance of a market index. Index funds may strive to track market indexes such as the S&P 500 Index, the Russell 2000 Index, and the Wilshire 5000 Total Market Index.
A market index monitors the performance of a “basket” of securities (such as stocks or bonds) that are intended to reflect a sector of a stock market or an economy. Although you cannot invest directly in a market index, index funds that monitor a market index give an indirect investing opportunity.
What exactly is an index fund?
Index funds can track a market index in a variety of ways: some invest in all of the assets in a market index, while others invest in only a subset of the securities in a market index.
The market capitalisation of a corporation is frequently used by market indexes to determine how much weight that securities will have in the index. The market capitalization (or “market cap”) of a corporation is a measure of the entire value of its shares. The total value is equal to the share price multiplied by the number of outstanding shares. Securities with a higher market capitalization value account for a larger share of the index’s overall value in a market-cap-weighted index. Some market indices are “price-weighted,” such as the Dow Jones Industrial Average. In this situation, the weight of a security is determined by its price per share.
Some index funds may also use derivatives (such as options or futures) to assist them meet their investment goals.
How do index funds make investments?
Index funds have historically been more passive than active investors. This means they want to optimise long-term returns by not buying and selling shares frequently. An actively managed fund, on the other hand, frequently aims to outperform the market (typically as measured by some kind of index) by making more frequent acquisitions and sales.
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