An index fund is a type of investment vehicle that seeks to replicate the performance of a specific financial index, such as the S&P 500 or the IBEX 35. Unlike actively managed funds, where managers attempt to outperform the market, index funds are designed to closely track the performance of a particular index.

The operation of an index fund is relatively simple. Fund managers select a basket of assets(stocks, bonds, etc.) that reflects the composition of the index they are trying to replicate. They then hold that basket constant, adjusting it only when the underlying index changes (e.g., due to changes in asset weightings or the entry/exit of index constituents).

The main advantage of index funds is their focus on passivity and simplicity. Since they do not require an active asset selection process, they tend to have low management costs compared to actively managed funds. This can result in higher net returns for investors over time.

When looking to invest in index funds, it is important to research the underlying indexes that the fund tracks, as well as its performance history and associated costs. Examples of popular index funds include those that track indexes such as the MSCI World, which tracks stocks of companies around the world, or the Vanguard Total Stock Market Index Fund, which seeks to track the performance of the entire U.S. stock market.

The compound interest strategy also applies to index funds. As investments generate gains, those gains are automatically reinvested in the fund, which can increase growth potential over time. This is called the snowball effect.