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How do index funds track the market and generate returns?

Curious about index funds

How do index funds track the market and generate returns?

Index funds are designed to track the performance of a particular market index, such as the S&P 500, by investing in the same stocks that make up that index. The fund manager will attempt to replicate the index's performance by purchasing all of the stocks in the index, in the same proportion as the index itself.

Since the fund is simply tracking the index, there is typically less need for the fund manager to conduct extensive research or analysis of individual stocks, which can help keep costs low. This passive approach is often contrasted with actively managed mutual funds, where the fund manager seeks to outperform the market by buying and selling stocks based on their own research and analysis.

The returns generated by an index fund will generally mirror the performance of the underlying index, minus any fees or expenses associated with the fund. So, if the index goes up by 10%, the index fund should also go up by a similar amount, assuming there are no major deviations from the index's composition or weighting.

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