Legal Definitions - index fund

An index fund is a type of investment fund, often structured as a mutual fund or exchange-traded fund (ETF), that aims to replicate the performance of a specific financial market index. Instead of actively selecting individual stocks or bonds, an index fund holds a portfolio of securities designed to mirror the composition and weighting of its chosen benchmark index, such as the S&P 500, the Dow Jones Industrial Average, or a bond market index. This passive investment strategy typically results in lower management fees compared to actively managed funds.

Here are some examples to illustrate how an index fund works:

• Example 1: Retirement Savings

  Sarah is planning for retirement and wants a simple, low-cost way to invest in the broader U.S. stock market. She decides to invest a portion of her savings into an index fund that tracks the S&P 500. This fund automatically buys and holds shares of the 500 largest U.S. companies in the same proportions as they appear in the S&P 500 index. Sarah doesn't need to research individual companies; her investment grows or shrinks in line with the overall performance of these major U.S. corporations, without the higher fees associated with a fund manager actively picking stocks.

• Example 2: Institutional Investment Strategy

  A university endowment fund, responsible for managing billions of dollars to support academic programs, decides to allocate a significant portion of its portfolio to a global bond index fund. The fund's investment committee believes that achieving broad diversification across international government and corporate bonds, without attempting to outperform the market through active trading, is the most prudent long-term strategy for this segment of their assets. By using an index fund, they gain exposure to a wide array of bonds from different countries and issuers, mirroring the performance of a global bond market index, while keeping management costs low for their beneficiaries.

• Example 3: Sector-Specific Investment

  David is interested in the growth potential of the technology sector but doesn't want to risk picking individual tech stocks. Instead, he invests in an index fund that specifically tracks a technology sector index. This fund holds shares in many different technology companies, from established giants to emerging innovators, in proportion to their representation within that particular tech index. This allows David to participate in the overall performance of the technology industry without having to analyze and select individual companies, providing diversification within that specific market segment.