Mutual funds vs Index funds: What’s the difference?

In this article

  • Mutual funds and index funds have emerged as the two primary contenders for your investable dollars.
  • A fund manager picks and chooses the best companies in which to invest based on meticulous research and market analysis.
  • Both types of investment funds invest in the stocks, bonds, and securities of companies across various industries.

So you’ve finally decided to take the plunge and start investing. If you’re on this article, you’ve probably already played the risky game of stocks and shares, and are looking for something more balanced, researched, and with greater potential for either safety or returns – depending on whether you’re a risk-taker or a long-term holder.

Mutual funds and index funds have emerged as the two primary contenders for your investable dollars – because of their historical performance of making people richer, or at the very least, helping them not get any poorer!

Now you’re at a crossroads – should you invest in mutual funds or index funds? It really depends on the type of investor you are – as both have their benefits and drawbacks. This article aims to shed light on the right investment choice for you – mutual funds or index funds? 

Primary objective of the fund

While both mutual funds and index funds aim to earn a profit for their investors, both fund types go about this in different ways.

Mutual funds aim to beat the closest related benchmark index by investing in a wide variety of stocks and securities.

Index funds aim to match – or draw parallel – with the chosen benchmark index (like the S&P 500 or Nasdaq Composite, etc) by only investing in stocks and securities listed in these indexes.

Method of management

Index Funds and Mutual Funds operate largely in the same way – a fund manager picks and chooses the best companies in which to invest based on meticulous research and market analysis. Mutual funds and index funds are very similar in this regard – except that:

Mutual funds are actively managed – meaning that fund analysts and fund managers actively pick stocks from various companies based on a number of factors on a daily or hourly basis.

Index funds are passively managed – meaning that the mix of companies chosen to invest in is automated to be parallel with the index against which the fund is benchmarked – happens automatically.

Method of investment

Both types of investment funds invest in the stocks, bonds, and securities of companies across various industries.

Mutual funds invest in all stocks, bonds, and securities.

Index funds invest only in stocks, bonds, and securities of companies listed in the particular index.

Management fee (aka Expense ratio)

In an ideal world, investment funds would have no management fee or expense ratio eating into your profits at the last stage, before the liquidation, but on average, expense ratios for:

Mutual Funds: Are around 0.85%

Index Funds: Are around 0.09%

If you’re looking for general advice on which is better – index funds or mutual funds, you should also consider the following facts:

  • It takes exceptional skill, market analysis and luck for a mutual fund manager to make such good picks, buy and sell at the exact right time, and for the right amount – to beat a market index. There are many market indexes, and they have beat all but 10% of small-cap, mid-cap, and large-cap fund managers running traditional mutual funds.
  • Index funds came about as a result of the market index constantly beating traditional mutual funds.
  • The entire point of an index fund is to mimic the index exactly – in order to make the right decisions regarding buying, selling, and volume.
  • Index funds are way cheaper in terms of management costs as they are passively managed by an automated system and not a human being. So none of your expenses are going toward paying off massive wall street salaries. Mutual funds that are actively managed may cost more and have the chance to beat the market index, depending on the skill of the fund manager.

If you’re a new investor just starting out – index funds may be the best bet to get the highest bang for your buck – as no part of the management cost goes towards paying off million-dollar salaries for wall street employees. If you’re a bit more well-versed in the complex field of investments and funds – you may consider studying the different funds available to you, the different managers that handle these funds, and their historical performance – before you make a decision.

 The goal is simple – make your money work for you. If you’re a risk-taker – find the best high-risk high-return mutual fund, if you’re risk-averse, find a good index fund for the long haul (also note that the risk factor high-return index funds are considerably lower, as the buy/sell actions happen based on the movement of the index itself).

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This page is purely informational. Line does not provide financial, legal or accounting advice. This article has been prepared for informational purposes only. It is not intended to provide financial, legal or accounting advice and should not be relied on for the same. Please consult your own financial, legal and accounting advisors before engaging in any transactions.

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