An index fund will
attempt to achieve its investment objective primarily by investing
in the securities (stocks or bonds) of companies that are included
in a selected index.
Some index funds may also
use derivatives (such as options or futures) to help achieve their
investment objective. Some index funds invest in all of the
companies included in an index; other index funds invest in a
representative sample of the companies included in an index.
The management of index funds is more "passive" than the
management of non-index funds, because an index fund manager only
needs to track a relatively fixed index of securities. This usually
translates into less trading of the fund’s portfolio, more favorable
income tax consequences (lower realized capital gains), and lower
fees and expenses than more actively managed funds.
Because the investment objectives,
policies, and strategies of an index fund require it to
purchase primarily the securities contained in an index, the fund
will be subject to the same general risks as the securities that are
contained in the index. Those general risks are discussed in the
descriptions of stock funds and bond funds. In addition, because an
index fund tracks the securities on a particular index, it may have
less flexibility than a non-index fund to react to price declines in
the securities contained in the index.
Another type of investment company that attempts to track the
performance of a market index is an exchange-traded fund (ETF). ETFs
are legally classified as either UITs or open-end companies, but
they differ from traditional UITs and open-end companies in a number
of respects. For example, pursuant to SEC exemptive orders, shares
issued by ETFs trade on a secondary market and are only redeemable
in very large blocks (blocks of 50,000 shares, for example). ETFs
are not considered to be, and may not call themselves, mutual funds.
Before investing in an index fund,
you should carefully read all of the fund’s available information,
including its prospectus and most recent shareholder report.
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