Index Funds

Index funds are designed to produce the same return as the index which they mirror, like the S&P 500, which tracks the performance of 500 large-cap U.S. stocks, or the NASDAQ Composite Index, which tracks technology stocks listed on that exchange. Though you could invest in all of the companies that a particular index follows, index mutual funds allow you to do so for much less money and with much greater ease. Instead of having to purchase each underlying security, you can simply purchase shares of the fund.

In addition, index funds are passively managed, making them cost- and tax-efficient investments. Instead of the fund's managers deciding what to buy and sell and when to trade, as they do in an actively managed fund, an index fund's holdings change only when the securities in the underlying index change. Because most index funds update their portfolios as infrequently as once a year or less, they pay out fewer capital gains distributions than a fund that changes its portfolio regularly. Furthermore, operating expenses are reduced because less day-to-day administration and oversight is required.

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Not all index funds are constructed in the same way. Though most practice replication and buy shares in all of the holdings of a particular index, this is not the only approach.

Enhanced funds, for example, purchase only a select number of securities within the index's portfolio with the objective of producing a slightly higher return than the index. However, enhanced funds aim to beat the index by no more than two percentage points because any wider spread would classify them as actively managed funds. An enhanced fund generally identifies undervalued stocks, or uses other investment strategies like buying derivatives, to achieve a higher return. As with any investment, their potential for higher return signifies greater risk.

Like enhanced funds, quant funds (short for quantitative analysis) also attempt to beat the performance of an index, though this type of fund uses statistical analysis to select a portion of an index's holdings. Specifically, the fund holds the components expected to perform better than the index as a whole.

Diversification does not assure a profit, or protect against loss, in a down market.

Investors should consider the investment objectives, risks, charges, and expenses of a mutual fund carefully before investing. A prospectus contains this and other information. A mutual fund prospectus is available through or through a Scottrade branch office. The prospectus should be read carefully before investing.

The information and content provided in the Scottrade® Knowledge Center is for informational and/or educational purposes only. The information presented or discussed is not, and should not be considered, a recommendation or an offer of, or solicitation of an offer by, Scottrade or its affiliates to buy, sell or hold any security or other financial product or an endorsement or affirmation of any specific investment strategy. You are fully responsible for your investment decisions. Your choice to engage in a particular investment or investment strategy should be based solely on your own research and evaluation of the risks involved, your financial circumstances and your investment objectives. Scottrade, Inc. and its affiliates are not offering or providing, and will not offer or provide, any advice, opinion or recommendation of the suitability, value or profitability of any particular investment or investment strategy.