What is an Index Fund?

Answer:
Index funds are a type of Unit Investment Trust

(UIT) or mutual fund with an objective to match the return of a given index such as the Wilshire 5000 Total Market Index or the S&P 500 Composite Stock Price Index.

In order to simulate the given market, the index fund invests in the stocks and bonds of the companies that are included in the original index. Index funds use different approaches to meet their investment goals. For example, some index funds might invest in every single company listed in the index while others might select a representative sample of the index. Others still include derivatives such as options and futures to assist them in reaching their investment goals.

Index funds are among the more passively managed funds because the fund managers are only working with fixed amount of securities. However, because the fund works with a limited amount of securities, the fund manager has less flexibility when it comes to reacting to price declines in the index’s securities. For example, if the index as a whole is declining, your index fund’s value will decline as well. The fund manager won’t have the luxury of buying securities outside of the index in an attempt to offset the decline.


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