Index Funds

Index funds are a type of mutual fund whose investment objective typically is to achieve the same return as a particular market index, such as the S&P / TSX Index, or S&P 500 Index. An index fund will attempt to achieve its investment objective primarily by investing in the securities (stocks or bonds) of companies that are included in a selected index. Some index funds may also use derivatives (such as options or futures) to help achieve their investment objective. Some index funds invest in all of the companies included in an index; other index funds invest in a representative sample of the companies included in an index.

The management of index funds is more "passive" than the management of non-index funds, because an index fund manager only needs to track a relatively fixed index of securities. This usually translates into less trading of the fund's portfolio, more favorable income tax consequences (lower realized capital gains), and lower fees and expenses than more actively managed funds.

Because the investment objectives, policies, and strategies of an index fund require it to purchase primarily the securities contained in an index, the fund will be subject to the same general risks as the securities that are contained in the index. In addition, because an index fund tracks the securities on a particular index, it may have less flexibility than a non-index fund to react to price declines in the securities contained in the index.

Advantages:

• Low operating expenses.
• There is no decision-making required by the manager or the investor.

Disadvantages:

• Investors must be satisfied with market returns because that is the best any index fund can do.
• Managers cannot take action. Index fund managers are usually prohibited from using defensive measures, such as moving out of stocks, if the manager thinks stock prices are going to decline.
• There is no profit taking or rebalancing that takes place. These functions must be done by the investor.