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In general, after IPO, the transactions happening on the shares will be between buyer and seller and they won't go to the Organization. And after that companies rely on their earnings, debts and secondary offerings to operate the business.

But in case of Index Funds Organizations like S&P, how do they raise money to purchase new shares?

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    It's not clear what you're asking - S&P is not an "index fund" - they publish indices that other fund benchmark against, but they do not buy stocks themselves. Can you clarify a bit more what you're looking for? – D Stanley Apr 14 at 3:46
  • Sorry for the confusion, here I mean the funds that tracks S&P like SPY(SPDR S&P 500 Trust ETF). They don't get any money due to stock transactions(sell/buy) after initial offerings. So my question is how they raise money to buy new stocks. – mano Apr 14 at 21:51
  • Relevant: Understanding how an ETF works – Flux Oct 12 at 9:39
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I think you're conflating three different concepts. It's true that companies that issue stock don't profit from the trading of that stock in the open market, but that has nothing to do with indexes or index funds.

The S&P 500 index is just an index - it is a list of ~500 different stocks based on some criteria. It does not "own" anything - it just adds or remove stocks as needed when stocks fail to meet the criteria and need to be replaced.

Index funds like SPY get their stocks from "authorized participants" (e.g. large investment firms) that provide shares of the underlying stocks that they already own in exchange for units of the fund.

My Question is how ETFs that trade over exchange raise money?

It makes money by charging a relatively small management fee and other operating expenses for managing the fund, which is subtracted from the NAV (and thus the unit price) of the fund. SPY, for example, has a gross expense ratio of 9.5 basis points (0.095%). So if you have $10,000 in SPY units, over the course of a year, if nothing else changed, you'd see the value drop by $9.50. That may not seem like a lot, but when you consider that the ETF has a total value of $280 Billion, that means that the fund makes $266 Million annually just for buying/selling stocks on a list.

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  • What does units mean here in "As investors buy more units" ? Does it mean stock units of SPY? If investor buy stock units of SPY then it will go to buyer. For example: As a investor if I buy 100 units today with current unit price of $283, this will go to buyer, right? Sorry if I am wrong. I am trying to understand by making comparisons between ETF stocks and regular stocks – mano Apr 15 at 1:25
  • SPY is an ETF, so retail investors don't directly purchase from, or redeem to, the fund, nor does it invest directly, although there are trad funds tracking S&P500 which do work this way. See money.stackexchange.com/questions/104932/… money.stackexchange.com/questions/104034/… money.stackexchange.com/questions/91271/… money.stackexchange.com/questions/96621/… – dave_thompson_085 Apr 15 at 5:09
  • @mano I mean units of the fund. If you own units of a fund you don't own the stocks themselves. The fund owns the stocks. It's like owning stock in Apple. You own part of the company, but not the phones - you can't walk into an apple store and take a phone just because you own apple shares. – D Stanley Apr 15 at 12:45
  • @Stanley, Thank you for taking time in explaining. Here in the above example, I said what if I buy the SPY stocks not the stocks that SPY bought with fund. If I buy SPY stock, that money goes to buyer. My Question is how ETFs that trade over exchange raise money? – mano Apr 16 at 0:01
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The S&P is an index, not an index fund. Maintaining an index doesn't involve buying any shares. It requires nothing more than keeping track of stock prices. For instance, I could pick say 57 stocks, with very little programming effort track their value over time, and thus create the "Heinz 57 Index".

Index funds raise money from people who decide to invest in that fund. For instance, if I decide to invest in say "Vanguard 500 Index Fund" (VFINX), I send Vanguard some money. Vanguard then uses that money (plus the money from all the other investors) to buy shares in companies that make up the index.

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  • Thanks for explaining. Can you help me with these two questions? 1. So these Index funds won't be benefited with their own share transactions(sell/buy) just like independent company, right? 2. Will these index funds offer new stocks which dilutes their EPS like secondary offerings? – mano Apr 14 at 22:10
  • @mano: Your questions honestly don't make a lot of sense. A mutual fund company (which most likely offers many types of funds, not just index funds) makes money by charging fees for managing the fund - typically a fraction of a percent of the amount invested. The mutual fund company may or may not be a corporation. If it is, it could issue stock, but that's entirely apart from the stocks owned by its funds. – jamesqf Apr 15 at 3:53
  • I am sorry. I am still in process of learning. I thought all index funds are ETFs where they act like corporation and issue stocks. – mano Apr 15 at 23:57
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    @mano: This is far from true. Mutual funds have been around for nearly a century: en.wikipedia.org/wiki/Mutual_fund Index funds are a particular kind of mutual fund that tries to replicate the performance of a stock index, and they've been around for close to 50 years: en.wikipedia.org/wiki/Index_fund Exchange-traded funds (ETFs) are comparatively new, and I have to admit that I don't really see the point of them. – jamesqf Apr 16 at 3:39
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Basically your question boils down to "how does a mutual fund work?"

Simplified example:

Lets say you have $500,000 and you want to put that money to good use tracking the S&P 500 List. You could just buy $1,000 in shares of every company on that list. but then, as the value if the individual shares go up or down, any maybe some dropping out and being replaced, you´d have to come in at certain intervals to rebalance, meaning to sell some of the shares that have gone up or dropped out and using that money to buy the appropriate amount of those that have gone down or being newly introduced.

Now that is a lot of work, and you want your money to work for you, not work for your money.

So you hire somebody to do that work for you - a stock manager. Hmm, turns out he want to earn at least $150,000 a year. Well that is not good, that´s more than your average return from your investment.

So you talk to me and I have the same problem. So we pool our money, you put 500,000 in and I put 500,000 in. The manger has the same amount of work. He just have to buy double the amount of shares and we can share his wage between us, cutting costs for each of us in half. Still, much to expensive to make sense.

So we go on an take on others to put their money into the pool until we have a vast sum, say $100,000,000 for the manger to do basically still the same work. No we are talking. We only need 0,15 % of the sum invested to pay the wage, the rest of the returns go into all of our pockets.

And voila, we have created a mutual fund - specifically an index fund - of course you could also advise your fund manager not to follow the S&P 500, but pursue another investment strategy for other forms of mutuals.

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  • A good explanation, except that not all mutual funds are index funds. They started out, nearly a century ago, with the idea that the fund managers would use their stock-picking expertise to invest that pool of money in stocks they thought would do well, and be able to charge significant fees for that expertise. Index funds came along half a century later, with the idea that by eliminating the well-paid expertise, and just automatically buying whatever stocks make up some particular index, you see a better overall return. – jamesqf Apr 16 at 18:42
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    @jamesqf You are right and I didn´t intend to imply that they are. I´ll try to make it clearer in my answer. – Daniel Apr 16 at 19:22

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