Index Funds Or Mutual Funds?
Which should you invest in- mutual funds or index funds? What's the difference and which is a better option for you? First, let's discuss the commonalities of these two types of investments. Both are great tools to help you diversify, allowing you to buy shares in many comnpanies at once. Basically, mutual funds and index funds both own shares in many stocks and when you purchase the fund you are buying a small portion of all the stocks owned by the fund. However, there are some major differences between index funds and mutual funds you should know about before you make a decision on which to invest in.
Active Management vs. Passive Management
The main difference between index funds and mutual funds is that mutual funds are actively managed while index funds are passively managed. This means that mutual funds own stocks purchased by a mutual fund manager, whereas index funds simply own shares in indexes like the S and P 500 or the Dow Jones Industrial Average. While mutual funds have a manager picking the stocks that constitute the mutual funds, index funds typically own shares in the companies that make up the index in roughly equal proportion to how much of the index the stock comprises.
How Good Is Your Manager?
This is the key question when you should be evaluating when you are deciding whether to invest in a mutual fund or an index fund. Mutual funds are almost always going to have higher fees than index funds because they must pay their managers. If the mutual fund manager picks the stocks that make up the fund well enough to have the return cover their fees than it is likely worth it to invest in the mutual fund. If you think you've found the next rock star mutual fund manager like Peter Lynch then it is definitely worth it to invest in the mutual fund. However, many mutual funds do not beat the market, which means your are actually paying someone to lose money vs owning the overall market via purchasing an index fund. You can read more about mutual fund performance here:
Conclusion
So while index and mutual funds share many characteritics, there are also many important differences. Mutual funds are slighty more risky than index funds due to the added possibility that the mutual fund manager will underperform the market. The basic takeaway of this artice then is that you should heavily scrutinize your mutual fund manager and the fees they charge- if you are not comfortable and happy with what you learn, then you are likely better of simply investing in an index fund.
