Mutual Funds vs Index Funds: What Are the Differences?

mutual funds vs index funds
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In 2020, about 46% of US households owned mutual funds, up from just 6% in the year 1980.

If you are investing your money, you have several choices on what to invest in. With around 8,000 different mutual funds and index funds available to invest in, it can be confusing to determine the differences.

It all comes down to what kind of investor you are and what your needs are. However, you must know the differences between mutual funds vs index funds to help in your decision-making and to ensure that you fully understand what this kind of investment is. Continue reading to know more.

Investment Objective and Management Style

There are two main types of investment funds, mutual funds and index funds. Both have their own benefits and drawbacks.

Mutual funds are managed by a team of professional investors who actively buy and sell stocks in an attempt to beat the market. However, this active management comes at a cost, as mutual fund fees are typically higher than index fund fees.

Mutual funds may fall into one of four main categories. They are the bond funds, money market funds, target date funds, and stock funds.

On the other hand, index funds are passively managed, meaning they simply track a specific market index (such as the S&P 500). This hands-off approach means index fund fees are typically much lower than mutual fund fees.

Where the Money is Invested

A mutual fund company that pools money from several investors uses the money to make investments in securities like bonds, stocks, and short-term debt. On the other hand, index investing enables you to invest in the biggest American corporations with little risk and low fees.

Average Fee for Account Management

When it comes to average fees for account management, mutual funds typically charge more than index funds. This is because mutual funds are actively managed, meaning that there are professional investors making decisions about which stocks to buy and sell.

Mutual fund expenses are calculated as a proportion of your total investment. Typically, they range from 0.5% to 1.5% for funds that are actively managed and 0.2% for passively managed funds.

The expense ratio for an average stock index fund is 0.09%. This translates to less than a penny for every $100 invested.

It is best that you get more information regarding this before you open a brokerage account. Because you don’t want to be spending so much on fund management fees.

How to Invest in Index Funds

If you are planning to invest in index funds, then there are just simple steps to get you started. First, you will just have to pick the index that you are interested in tracking.

However, you must know that there are hundreds of different indexes you can track using index funds. But the most popular index is S&P 500 Index, which includes the top 500 companies in the United States stock market.

Next, you have to choose a fund that tracks your selected index. If you choose the popular S&P 500, then you can find a dozen or even more choices to follow the same index.

Finally, buy some shares of that index fund. In order to do this, you must open a brokerage account, so you can buy and sell shares of that particular index you have chosen. It is also an alternative that you open an account directly with such a mutual fund company that is offering that fund.

How to Invest in Mutual Funds

When you have made the decision to invest in mutual funds, you must first decide if you should go active or passive. Professional fund managers actively manage the funds. They conduct market research and make buying decisions in order to outperform the market.

While for passive investing, this is one hands-off approach and is becoming more popular too. The two types of mutual funds for passive investing are index funds and exchange-traded funds. The ETFs have the advantages of mutual funds in terms of diversification and can be traded like individual stocks.

There are also no-load mutual funds. A no-load mutual fund is a kind of mutual fund wherein the shares are sold with no commission or sales charge.

The next thing is that you have to calculate your budget and choose where you are going to purchase mutual funds. A lot of investors opt to purchase through an online brokerage account that offers a broad selection of funds from different companies. You may buy directly from the company which created the fund, but when you opt for this route, you will have limited fund options.

Have Your Made Your Decision Between Mutual Funds vs Index Funds?

There are many of those who are risk-takers and want to keep investing their hard-earned money instead of letting it sleep in the bank. Well, there are different investment vehicles available nowadays that will suit any type of investor.

After reading the points above, can you now tell which is better in mutual funds vs index funds? It depends. A mutual fund may be a better option if you want to try to beat the market.

However, if you’re happy with just matching the market’s performance, then an index fund is a better choice. Index funds are also generally less expensive than mutual funds, so they may be a better option for long-term investors.

For more information and advice on mutual funds vs index funds, check out the rest of our blog for more resources for your investment needs.