An index fund is designed to mirror the performance of a stock or bond index, such as Standard & Poor's 500 Index (S&P 500) or the Russell 2000 Index.
To achieve that goal, the fund purchases all of the securities in the index, or a representative sample of them, and adds or sells investments only when the securities in the index change. Each index fund aims to keep pace with its underlying index, not outperform it.
This strategy can produce strong returns during a bull market, when the index reflects increasing prices. But it may produce disappointing returns during economic downturns, when an actively managed fund might take advantage of investment opportunities if they arise to outperform the index.
Because the typical index fund's portfolio is not actively managed, most index funds have lower-than-average management costs and smaller expense ratios. However, not all index funds tracking the same index provide the same level of performance, in large part because of different fee structures.
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