Question

Describe how an index tracking fund operates. What are some of the problems faced by Index tracking funds?

Answer 1

These are financial instruments you buy from a fund company that aim to track the performance of an index. ... Trackers and ETFs work either by physically buying a basket of investments in the index they're tracking or by using more complicated investments to mimic the movement in the index.

What Is an Index Fund?

An index fund is a type of mutual fund or exchange-traded fund (ETF) with a portfolio constructed to match or track the components of a financial market index, such as the Standard & Poor's 500 Index (S&P 500). An index mutual fund is said to provide broad market exposure, low operating expenses, and low portfolio turnover. These funds follow their benchmark index regardless of the state of the markets.

Index funds are generally considered ideal core portfolio holdings for retirement accounts, such as individual retirement accounts (IRAs) and 401(k) accounts. Legendary investor Warren Buffett has recommended index funds as a haven for savings for the later years of life. Rather than picking out individual stocks for investment, he has said, it makes more sense for the average investor to buy all of the S&P 500 companies at the low cost an index fund offers.

• An index fund is a portfolio of stocks or bonds designed to mimic the composition and performance of a financial market index.
• Index funds have lower expenses and fees than actively managed funds.
• Index funds follow a passive investment strategy.
• Index funds seek to match the risk and return of the market, on the theory that in the long-term, the market will outperform any single investment.

How an Index Fund Works

"Indexing" is a form of passive fund management. Instead of a fund portfolio manager actively stock picking and market timing—that is, choosing securities to invest in and strategizing when to buy and sell them—the fund manager builds a portfolio whose holdings mirror the securities of a particular index. The idea is that by mimicking the profile of the index—the stock market as a whole, or a broad segment of it—the fund will match its performance as well.

Index investing is a strategy that involves creating portfolios around a stock index, a benchmark, or a market average.
The problems include...

• Lack of Downside Protection. ...
• Lack of Reactive Ability. ...
• No Control Over Holdings. ...
• Limited Exposure to Different Strategies. ...
• Dampened Personal Satisfaction.