What is an Index Fund?

can someone give me a "step-by-step" explanation of an index fund, how does it work, advantages-disadvantages, please include an example!! a "step-by-step" example. start from: Marco is not a US citizen (as in lives in another country) and wants to invest in an index fund.... (so i duno the other choices for S&P 500 or whatever...)

An index fund is an investment product that is designed to track the movement of given index (such as the S&P 500.) They use little or no real world managers and are now often strictly operated on a computer model. Since no model or manager is perfect, there will always be a slight variation from the index to the index fund.

The main advantages of an Index fund are that they have significantly lower expense ratio (fees) than mutual funds. They allow exposure to foreign markets without requiring the expertise of selecting foreign equities. Probably the biggest strength of index funds is their ability to consistently outperform the overpriced manager-run mutual funds. This was first pointed out in Malkiel's "A Random Walk Down Wall Street." In fact, many individuals in the investment product development community credit Malkiel as the father of index funds and ETFs.

The disadvantage would be that you know, going in, you have no chance of significantly outperforming the index you are purchasing into. So you could miss out on a huge booming equity that a real world fund manager may have caught on to.

A mutual fund is a type of investment where a company (e.g. Vanguard, Fidelity, American Century, T. Rowe Price) buys many stocks and put them in the fund. People then invest money in the fund. So basically, if a million people each put $100 into the fund, the fund manager will take that $100 million and buy a lot of different stocks and each investor in the fund owns a tiny bit of each.

Every day, the company totals up the value of the stocks in the fund, subtracts out a very small amount to pay them for the management of the fund, and divides the value by the number of shares in the fund to determine the value per share of the mutual fund.

Mutual funds are set up with specific goals. Some invest only in gold stocks, some invest only in companies from a certain country, etc. An "index fund" is one that invests in the companies of a particular stock market index. There are many different indexes, but two of the more well known are the S&P 500 (which consists of 500 large company stocks) and the Russell 2000 (which consists of 2000 smaller company stocks).

I personally think an index fund is a great investment for a new investor. With a small amount of money, you can easily buy a little bit of a lot of different companies. That protects you from the risk of having the one company you buy stock in go bankrupt and losing all your money. If one company in the fund goes bankrupt, you still have all the other companies, so you don't lose much.

One thing to beware of is funds with "loads", which is a fee that's charged when you buy (and sometimes when you sell the fund). They can be very high - like 6% - which can take a big chunk out of your earnings. I personally only buy "no-load" funds that do not have this charge.

For more information, check the websites of any of the four companies I mentioned above.

An index fund is a type of mutual fund.

Mutual funds are investments that are bought and labled like stocks--but they are actually groups of stocks (and/or bonds and/or other investments). So individuals can buy shares of one mutual fund and own a diverse collection of stocks and bonds.

Mutual funds are generally managed by a person or a team of professionals who pick the stocks that make up the fund. These expensive professionals make a lot of money, so mutual funds generally charge high fees, sales charges, and loads.

The goal of most mutual funds is to outperform the "market"--as measured by an index. There are dozens of indexes--they can measure entire markets (us stock market index) or sectors (homebuilder stock index) or any group of investments. Most funds fail to beat the market though!

So investment companies offer investors the option to just invest right in the index. Since there's a specific group of investments in each index, there's no need to have expensive managers--index funds are managed passively by computers. Therefore they have much lower fees. They also have very low turnover (not a lot of buying and selling of holdings) so they don't generate as many taxable gains as regular funds.

So index funds are cheaper, taxed less, and outperform most actively managed mutual funds.