Index Funds

Passive Mutual Funds that replicate well-known market indices are called Index Funds. The fund manager only Invests in all of the Stocks that comprise the index to be followed; they do not actively choose the industries and stocks to be included in the fund’s portfolio. Each stock in the index is weighted similarly to how the equities in the fund are weighted. This is a passive investment, meaning that the fund management builds the fund’s portfolio by simply copying the index and makes an effort to keep the portfolio consistently in line with the index.

The Fund Manager must purchase or sell units of a stock if its weight in the index shifts in order to bring the stock’s weight in the portfolio into line with the index’s. Although Passive Management is simpler to understand, tracking error causes the fund to occasionally underperform the index.

Because holding the index’s securities in the same proportion is never simple and the fund incurs transaction expenses in the process, tracking inaccuracy happens. Even with tracking error, index funds are the best option for people who wish to benefit from exposure to the larger market but don’t want to take on the danger of investing in mutual funds or individual equities.