SECTION 5 INDEX FUNDS
Chapter 12: Index Funds
An index fund is a bundle of stocks. The stocks that the fund holds are the same stocks, with the same weightings (percentages) as the stocks represented in a particular index, such as the S&P 500 index. You cannot own an index. You can own the same stocks as the index—an index fund.
The only time a stock in an index fund is bought or sold is when the publisher of the index makes a change in its lineup. For instance, if the S&P 500 expels ABC Company and replaces it with XYZ Company, then any index fund tracking the S&P 500 will do the same thing. This is mutual fund investing in its simplest form.
Index funds are said to be “passively-managed” because there is really not much to manage, which is why the costs are so low. As it turns out, more intense managing does not equate to more money for mutual fund shareholders, only more money for Wall Street.
Index funds do not buy or sell stocks often because changes to the underlying index do not often occur. This keeps capital gains tax liability low. The index fund avoids the expense associated with a lot of buying and selling—such as high-priced analysts, costly research, and the expense of conducting numerous transactions. The savings enable these funds to compete very effectively with mutual funds that are trying to beat the market.
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