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I have read that index funds are 'passively managed', but I am not entirely clear on how they actually work. Could someone please enlighten me?

Let's assume I would like to invest in the popular Vanguard 500 S&P Index. If I put in $1000 today, that amount gets distributed among the 500 companies based on their index percentage (right?) and if I invest into it $5000 after couple of months, its going to be a similar procedure I think.

Question: Since stocks in companies can go up or down, who manages to make sure that my account is not severely affected by this? An example:

Let's say out of the $1000 investment, 25%($250) are invested in company A. Now company A has been doing ok for couple of weeks, but then due to some factors in that company its stock has been tanking heavily and doesn't appear to have a chance to recover. In this kind of scenario, what does happen? Am I responsible of moving my money from the index fund to a different fund entirely or do the managers of index funds do something about it? Basically I am not clear on what 'passively managed' is I think.

Kiran
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1 Answers1

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Now company A has been doing ok for couple of weeks, but then due to some factors in that company its stock has been tanking heavily and doesn't appear to have a chance to recover. In this kind of scenario, what does happen?

In this scenario, if that company is included in the index being tracked, you will continue holding until such time that the index is no longer including that company.

Index funds are passively managed because they simply hold the securities contained in the index and seek to keep the allocations of the fund in line with the proportions of the index being tracked. In an actively managed fund the fund manager would try to hedge losses and make stock/security picks. If the manager thought a particular company had bad news coming maybe they would offload some or all the position. In an index fund, the fund follows the index on good days and bad and the managers job is to match the asset allocations of the index, not to pick stocks.

quid
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