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An S&P500 index fund will hold each of the 500 stocks that are in the S&P 500.
Does it target holding an equal number of shares of each stock? An equal dollar amount? Does this vary based on a particular index fund or what the fund is mirroring?
I found this question: How does an index rearrange its major holdings
That question seems to be what an index fund does after it's out of balance. I'm curious how it knows it is in balance.
In general, the goal of an S&P 500 index fund is to replicate the performance of the S&P 500 Index. To do this, the fund will buy the same stocks in the same proportions as the weighting of the Index.
The S&P 500 Index is free-float capitalization weighted. This means that the higher capitalization stocks (based on publicly traded shares only) are more heavily weighted and factor into the Index value more heavily than the smaller capitalization stocks, or the stocks that have a smaller publicly traded value. For example, companies like Apple, ExxonMobil, and Microsoft have a much larger weight in the index value than smaller companies.
Alternatively, there are some S&P index funds that are equal-weighted. In these funds, the managers have chosen to purchase all 500 of the stocks in the index, but in equal proportions instead of the weighted proportions of the index. These equal-weighted funds will not as closely match the index price as the traditionally weighted index funds. Instead, they might do better or worse than the index, depending on how the individual stocks do.
You'll need to look at the prospectus of the index funds you are interested in to see which approach the fund is taking.
An index fund is just copying the definition of an index. The group that defines the index determines how to weight the different parts of the index. The index fund just makes sure they invest the same way the index creator wants.
Think of a non-investment scenario. A teacher can grade tests, quizzes, homework, in-class assignments, research papers. They decide how much weight to give each category and how much weight to give each part of each category.
when a student wants to see how they are doing they take the information in the syllabus, and generate a few formulas in a spreadsheet to calculate their current grade. They can also calculate what they need to get on the final exam to get the grade they want.
Yes, it depends on the fund it's trying to mirror. The ETF for the S&P that's best known (in my opinion) is SPY and you see the breakdown of its holdings. Clearly, it's not an equal weighted index.
Note that an index fund may not be able to precisely mirror the index it's tracking. If enough many people invest enough money into funds based on that index, there may not always be sufficient shares available of every stock included in the index for the fund to both accept additional investment and track the index precisely.
This is one of the places where the details of one index fund may differ from another even when they're following the same index. IDEALLY they ought to deliver the same returns, but in practical terms they're going to diverge a bit.
(Personally, as long as I'm getting "market rate of return" or better on average across all my funds, at a risk I'm comfortable with, I honestly don't care enough to try to optimize it further. Pick a distribution based on some stochastic modelling tools, rebalance periodically to maintain that distribution, and otherwise ignore it. That's very much to the taste of someone like me who wants the savings to work for him rather than vice versa.)
as long as I'm getting "market rate of return" or better on average across all my funds I was under the impression that it's not possible to do this consistently due to fund expenses and transaction costs.