HOW INDEX FUNDS ARE STRUCTURED
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Many investors wanting their investment portfolios to keep pace
with the market choose index funds.
Simply put, index funds
contain the securities that make up major market indexes.
They do not try to beat the market. Instead,
they try to match it.
An index fund that tries to match an index would hold the same
securities that are in that index. The fund may weight the number of shares for
each company it owns in proportion to the share price or company capitalization.
For example, it may buy more shares of a company whose share price is lower than
one with a higher share price. Alternatively, it may buy more shares of a large
company than of a small company regardless of share price. The fund's prospectus
describes the method of allocation. The fund may try to mimic the formula used
in the index itself to achieve the same results as the index.
Index funds require little to no active management. In most
cases, computer-trading software dictates the portfolio allocation to match the
chosen index. Buying and selling is infrequent because market indexes do not add
or replace securities very often. As a result, portfolio turnover and management
expenses are low.
Some commonly used indexes include the S&P 500, Wilshire
5000, the S&P Midcap 400, the Russell 2000, and Lehman Brothers Aggregate
The following screen explains more about how index funds