Expert: Steve Hach - 8/18/2010

Question
Hi,

I recently purchase an index fund locally but when I check
and call the bank, the bank officer can't and don't know the
answer I ask for.

I ask them how an index fund company operate and earn money,
I know they are charging approximately 0.15% average to make
money but the question I have is when we bought the index
fund from the stock market or during listing time the money
index fund company collected via IPO will all purchase back
to the share market or how ?

For example the Vanguard 500 index fund, did Vanguard really
purchase 500 shares from the market during IPO ?

Thanking in advance!

Answer
Hi There,

The index fund buys and sells stocks/bonds/commodities/etc. to keep a portfolio which tracks the index in question.

So, if the fund in question is supposed to track the sp500 index, they would allocate their holdings so that they were holding all sp500 components--individual stocks--so that in theory the index fund would exactly match the performance of the index--minus the small management fee.

When Vanguard set up the fund, they would buy all of the stocks in the SP500 and then keep the portfolio so that you would get almost the same performance of the sp500 without having to purchase all of the shares yourself.

It provides a cheap an easy way for an investor to get the same performance.

You can read more here:
http://www.investorwords.com/1755/ETF.html

Best,

Steve