Stock index fund
Family I · Instruments
Not to be confused with index, limit stock order, index cfd.
Stock index fund is a pooled investment that aims to match the returns of a stock market index, such as the S&P 500 or FTSE 100, by holding the same securities in the same weights as the index. It is typically offered as a mutual fund or exchange-traded fund (ETF) and is managed passively, meaning the fund manager does not attempt to beat the index. The fund's value rises and falls in line with the index it tracks, minus fees and expenses.
Structure and operation
A stock index fund may be structured as a mutual fund or an exchange-traded fund (ETF). In both cases, the fund's portfolio is constructed to mirror the composition of a target index. For example, a fund tracking the S&P 500 will hold shares of all 500 companies in approximately the same proportions as the index. The fund's manager makes trades only to adjust for changes in the index or to handle investor inflows and outflows, resulting in low turnover and lower costs compared to actively managed funds.
Investors buy shares of the fund, which represent a proportional claim on the underlying portfolio. The fund's net asset value (NAV) is calculated daily for mutual funds, while ETF shares trade on exchanges throughout the day at market-determined prices.
Worked example
Suppose an investor puts $10,000 into a stock index fund that tracks a broad market index. The fund has an expense ratio of 0.05% per year. Over one year, the index returns 8%. The investor's return before expenses would be $800. After deducting the annual expense ratio (0.05% of $10,000 = $5), the net gain is $795, and the ending value is $10,795.
Key characteristics
- Passive management: The fund aims to replicate the index, not outperform it.
- Diversification: By holding many securities, the fund reduces idiosyncratic risk.
- Low costs: Expense ratios are typically lower than those of actively managed funds.
- Market risk: The fund's value fluctuates with the overall market, as represented by the index.
Often confused with
- index
- An index is a statistical measure of market performance, while a stock index fund is an investable product that tracks that index; the visible sign is that an index has no share price or expense ratio.
- limit stock order
- A limit stock order is an instruction to buy or sell a specific stock at a set price, whereas a stock index fund is a diversified portfolio of many stocks; the visible sign is that a limit order is a temporary trading instruction, not a holding.
- index cfd
- An index CFD is a contract for difference whose underlying reference is a stock market index, such as the S&P 500 or FTSE 100, and which settles in cash for the difference between the opening and closing prices without any exchange of the underlying basket of shares.