An index fund is a type of mutual fund or exchange-traded fund (ETF) that aims to track the performance of a specific market index, such as the FTSE 100 or the S&P 500. Index funds are designed to provide investors with a broad, diversified exposure to the market, while minimizing the costs associated with active management.
An index fund is managed passively, meaning it holds a basket of securities that mirrors the composition of the index it is tracking, such as the FTSE 100, it will hold shares of the companies that are included in the index, in the same proportion as the index.
The main advantage of index funds is that they are cost-effective, as they do not require the research and analysis required for actively managed funds, which can drive up fees. Index funds also tend to have lower expense ratios than actively managed funds, which results in more returns for investors.
Another advantage is the diversification, an index fund provides, as it holds a broad basket of securities from different sectors, countries, and market capitalization, which helps to reduce the overall risk of the portfolio.
It’s worth noting that while index funds are designed to track the performance of a specific market index, they may not perform exactly the same as the index they are tracking, due to the tracking error which caused by the tracking fee, cash holdings, and other factors.
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