Are you wondering what a mutual fund is and what an index fund is, or are you trying to figure out which of the funds you should venture into? If you are curious and you want to learn the major difference between the two in order to make up your mind on which of the funds you should eventually settle for, here are a few tips to help you weigh your choice and also help you to finalize your decision. It is important to know that both funds generate money from investors and they both come with minimum risk, there are just a few differences in their managing style, the end goal, cost, and flexibility.
What Is a Mutual Fund?
A mutual fund is a type of investment that pools money from multiple investors and invests in a diverse portfolio of securities such as bonds and stocks. Typically mutual funds are less risky because they are well diversified and are invested in different portfolios. The shares in the mutual funds are known as mutual funds units and they are usually purchased at the fund’s net asset value- This is calculated by dividing the total value of the fund’s securities by the number of outstanding shares.
What is an index fund?
An index fund is also an investment fund that is found within the family of the mutual fund. It comprises bonds, stocks, and other types of investment. Index funds are intended as passive funds that habitually track an underlying index.
Compared to the mutual fund, an index fund, is normally managed actively with fund managers who are in charge of selecting investments and making a profit off the shareholder’s money.
Mutual funds vs index funds
One of the main advantages of index funds is that it permits the investor to invest in huge global stocks and you don’t have to invest in the stocks individually because this serves as a good way to spread your portfolio. Another unique feature of the index fund is that it allows you to invest your money and forget about it for a while, what this means is that the moment you choose the fund to invest in, you don’t have many decisions to make again, since you are tracking only one specific index and securities which a lot of people find pleasing because most people are comfortable with being a passive investor. The following are also major differences that you can find between a mutual fund and an index fund, when you know the differences that exist between these two funds, it becomes much easier to choose the appropriate funds to invest in.
The style of management
A major difference between a mutual fund and an index fund is the style of management, a mutual fund is active while an index fund is passive.
Mutual fund managers are always on the move, they are always looking for and actively selecting fund holdings like individual bonds or stocks, unlike index funds where managers are not actively trading or adding more investment.
Both mutual funds and index funds have different end goals. Index funds’ goal is to match the returns of the benchmark or the fees of the underlying index, this means that index funds seek to earn the same rate of return as the benchmark index, minus fees.
While mutual funds’ end goal is to beat the returns of a comparable or related benchmark index after fees.
It is important to note that if the market is unstable, it is always harder to pull your funds out on short notice because advance notice is a key requirement.
Are you wondering which one will cost you more?
A mutual fund is likely to cost you more especially in terms of fees, mutual funds range from 1% to 3% upward while an index fund will cost you about 0.05 to 0.07% upward even though the prices may vary or differ.
Mutual fund tend to cost more because it is active and it is actively managed by fund managers, the fees are deducted from your fund assets annually and this means the fees are deducted from your returns.
If you want your fund manager to be able to move your assets freely without hindrance then you should consider investing in mutual funds because index funds don’t allow for much flexibility and this is a result of their passive nature.
Index fees attract lower fees and/or lower taxes on capital gains due to less turnover in stocks. It also allows for access to large, global stocks without having to actively invest in individual companies.
Index fund allows you to invest your fund and leave it because you do not have to track individual stocks and indexes every day. The risk associated with certain index funds, which are frequently referred to as “exchange-traded funds” or “ETFs,” is that they may become illiquid if fear begins to build up in the index that they track.
Still, both mutual funds and index funds offer convenient and often high-revenue generating opportunities for investors, so before you make up your mind make sure to carry out due diligence and figure out which one of either mutual fund or index fund best fits you, weigh your option with their unique features and also keep their end goal in mind.
Either one of them is great but you certainly need a lot of time and a lot of money, if you are looking for a perfect type of investment that has little risk then any of the two; a mutual or index fund will be a perfect fit for you.
If you want to be an active investor then the mutual fund is the way forward and if you want to be a passive investor then you can consider an index fund. With any investment comes risk, it is very important to carry out proper research before making up your mind on the type of fund to invest in.