Difference Between Mutual Funds and Index Funds

Mutual Funds and Index Funds

Hey guys. Welcome back to another one of my blog posts. Today I will be focusing specifically on investing and the differences between index funds and mutual funds. Mutual funds and index funds are similar in some ways but different in others. I’m here today to help answer some of the questions that you may have about these funds.

What are mutual funds?

Mutual funds are often funds that are made up of a collection of stocks and bonds. Usually an investment company manages these collection of financial assets. These funds will often contains stocks and bonds from a variety of financial sectors. For example certain mutual funds can contain assets from large-cap stocks, medium-cap stocks, small-cap stocks, the health sector, and the real estate sector. These mutual fund contains their own ticker symbols and will go up and down accordingly as the individual stocks in the funds goes up and down.

Normal investors like us can invest in mutual funds. Mutual funds are beneficial to us because it allows us to not put all of our proverbial eggs in one basket. The fact that a mutual fund contains stocks and bonds from 10,20, or even 30+ companies means that one company’s bad performance will not entirely deplete the amount you invested.

In exchange for investing in these mutual funds, you will often be charged a fee which will often be between 0% and 1% of what you invested. For example, a mutual fund that charges a .34% fee on a $10,000 investment will cost you $34 every time you are charged a fee. Note that this percent will vary from company to company. 

A mutual fund is also often managed in way called “active management”. This means that there will often be a portfolio manager behind these mutual funds that will be researching which stocks or bonds to include into their mutual funds. This means that assets will often be bought and sold by the portfolio manager in order to make their mutual fund as profitable as possible. 

What are index funds?

Index funds are somewhat similar to mutual funds because of the fact that they invest in a collection of stocks, bonds, etc. as well. The major difference between mutual funds and index funds is that mutual funds specifically invest in stocks from a specific index. Although you may or may not realize it, you have probably already heard of two very famous indexes. 

One such index is the the Dow Jones Industrial Average (DJI). The other index that you may have heard of is the S&P 500. The Dow Jones consists of 30 different stocks including companies such as Boeing, Apple, Coca-Cola, Microsoft, and many more! On the other hand the S&P 500 consists of a group of 500 of some of the largest American companies that are placed together. Together these companies make up these indexes. Instead of investing in a certain sector, investment companies for index funds will often in the stocks found in these indexes.

The fees associated with index funds will often be lower than that of a mutual funds because index funds are most often managed through what you would call “passive management”. The stocks and bonds found in index funds do not change. These index funds will follow their specific indexes as exactly as possible. That means that the index funds will probably not buy or sell their assets unless the committee that runs the index itself decides to change what is listed on their index. This also means that the costs associated with an index fund will be lower, meaning less fees for the investor.

Investing in index funds may seem useless, but its’ in fact not that bad if you really think about it. Some people are probably wondering “why invest in an index fund that will only get average returns of  a group of 50+ companies”? The reason for that is that the market has been known to have continuously gone up over the years. For example, the S&P was at about 100 and has steadily climbed to about the 1800 range. Obviously the market will go down when their is economic downturn. However, the US market has been known to have recovered through these crises (as the market has never gone to 0 and bottomed out, it’s highly unlikely for this to happen unless there’s is some sort of big catastrophe). Hence the market will probably continue to go up.

Another point to add is that a recent study has shown (according to my small bit research a while back) only about 15-30% (?) of certain mutual funds in a specific sector have been known to have outperform its’ index fund equivalent.

Current index fund investors are probably most attracted to index funds because it’s most often has the cheaper investment fees. At the same time they also probably attracted to them because they enjoy the concept of earning market average returns.

Conclusion

It may seem that I’m slightly biased to index funds. However, that is actually not true. I actually got started investing in mutual funds and I plan on doing so in the near future. Please note that if you plan on investing in funds the returns you make will vary from person to person and fund to fund. You may just get lucky and pick one mutual fund that will outperform the market. Or you may pick one index fund that end up making you no money at all! You never know! 

These are just some of the differences between mutual funds and index funds. In conclusion, mutual funds and index funds are similar in the fact that they are collection of stocks and bonds. They differ because of the way the stocks and bonds are chosen for each type of fund.

I have basically pointed out the most common differences between the two funds. I hope you enjoyed reading about mutual funds and index funds! Please feel free to leave a comment if you have any questions. I will try and answer it as soon as possible!

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