index fund definition

Index Fund Definition, Basics and Example

Index Fund Definition – A mutual fund that tracks the performance of an index or the returns of a market index.

Index refers to the basket of securities that represents a particular segment of the market. If you don’t  have much time and do not want to indulge yourself in understanding the market, then index fund is perfect for you. Investing in index fund is one of the best way to enter into stock market and diversifying the portfolio. The investors who are investing in index funds needs to be very patient as they do not result in huge cash outflows and cash inflows.

Characteristics of Index Fund

Cost is Low – Trading in index fund is comparatively cheaper than the separately buying and selling of underlying shares. Here the decision on which security depends upon the index rather than active management. Hence these funds have minimal expense ratio and are more affordable.

Diversification – As mentioned above, index fund tracks the performance of a market index which consist of group of securities. Hence the risk is diversified. In case an investor invests in single securities, then the risk is very high.

Liquidity – These funds are traded in the major stock exchanges on a daily basis. Volume of transaction is also very high which results in increasing the liquidity in this segment. Hence making it more convenient to buy and sell rather than underlying securities.

Index Fund Example

In order to understand Index Fund definition, let’s discuss an example.

Suppose Ram purchases a share of index fund, this implies that he has bought a portfolio that consist of securities of an underlying index. The index fund consists of the securities in the same proportion of the actual index. So when the index decreases, the funds shares also decreases.

Related Financial Terms of Index Fund