How do index funds track the performance of an index?

Index funds track the performance of an index by holding a portfolio of securities that closely replicates the index. For example, if an investor wants to invest in an S&P 500 index fund, the fund will hold the same securities as the S&P 500 index, in the same proportion. The fund manager will not make any active decisions about which securities to buy or sell, but will simply try to match the performance of the index by holding the same securities.

This approach is known as passive management, as the fund manager is not actively making decisions about which securities to hold, but rather passively holding a portfolio that mirrors the index. By holding a diversified portfolio of securities, index funds aim to provide broad exposure to the market and capture the returns of the index they are tracking.