<prompt> Human: Hi, Since the conventional wisdom here seems to say to use an index fund, Im wondering how the mechanics of an index fund actually work... I know what an index fund is... Im looking for an explanation of what goes on behind the scenes... Here are a couple of questions, for example: If I buy, for example, 100 shares of the SP500 index fund, does the fund really buy some number of shares of each of the 500 underlying stocks? If they didnt poolbatch orders, it seems like there would be a large overhead to purchase shares in each company. Assuming a lot of people have index funds in 401ks for example SP500, wouldnt that demand artificially increase a shares price at the 15th and 30th of the month? When a company is added to an index for example Apple to the Dow, doesnt the artificial price inflation reduce the index funds performance? Does an index fund use its proxy votes in the best interests of the shareholders? If a company is in an index, it seems to be guaranteed to have steady demand for its stock, no matter what its actual performance is.  <response>: Essentially, yes, the fund itself owns shares of each of the companies that make up the index. For example, the SP 500 index is comprised of the 500 largest by market capitalization companies. To recreate the index, you cant just own one share of each company, you have to own an integral whole number of shares of the companies in proportion to their relative capitalizations; and in order to get those proportions accurate to an acceptable degree of precision, you have to buy a large number of shares. Edit: There are lots of kinds of market indexes, and some indexes do not weight by market capitalization. The Dow Jones, for example, is weighted by price. Naturally, a fund tracking such an index would buy shares according to the weighting scheme employed by that index.Edit 2: Heres Jack Bogle talking about the history of index fundsThe index fund, like all mutual funds, allows investors to invest much smaller amounts of money and buy fractional shares of each company, so that investors can still cumulatively own the companies in proportion to their market capitalizations. The fund pools all the investors money and buys the individual shares of the companies on their investors behalf.Index funds do, as you suggest, make bulk purchases of underlying shares, to minimize costs. In fact, this practice was infamously exploited by high-frequency traders, who would anticipate the bulk orders from index funds coming down the line, and buy up a ton of shares in advance of the index funds orders, driving up the price for the index funds purchases, and then selling and pocketing the difference.Small price fluctuations are a drag on returns, but they are not generally significant in the big scheme of things. The price changes caused by index funds purchase orders are mostly lost in the market noise, overwhelmed by much larger fluctuations caused by market speculation. Also, there are lots and lots of index funds, and they dont all buy and sell at the same time; also, while you buy shares of the fund on the 1st and 15th, the fund buys shares of companies on their own schedule.Short video 