If you’ve been looking for a complete index vs mutual fund comparison, you’ve come to the right place!
Index and mutual funds share one basic similarity with each other; they are both supposed to help you invest without doing anything on your part.
But when it comes to their aims, fees, risk, and performance, they differ a lot; sometimes wildly…
In this article, we will outline the main aspects that make these two types of funds different and which you should consider as the better investment vehicle.
Let’s get into it asap!
The Goal and Approach
The first major difference between those two types of funds is their goals.
Basically, index funds are supposed to track the performance of an index as closely as possible.
Mutual funds, on the other hand, are all about beating the performance of an index.
We should also note that the goal of the fund manager will dictate their approach.
Take for example an index fund manager. Their strategy is passive, meaning they try to create and preserve a portfolio that will resemble a particular index. They don’t have milestones that they need to reach. Their job is to build a portfolio out of an index and make it behave the way the index does.
But a mutual fund manager’s job differs a lot. They pick a target and aim to beat it. Most often than not, you will see them trying to beat the market by setting a broad-market index like the S&P 500 or the DJIA as the benchmark.
In a while, we’ll see how well both types of funds achieve their goals…
Expenses
Another important index vs mutual fund difference and a deal-breaker (or maker) for investors is the expenses.
This is mainly determined by the expense ratio. It’s simply the percentage of the total amount invested that you will have to pay to the fund manager every year.
Say you invest $10,000 through a fund with an expense ratio of 1%. That means you will be paying the manager $100 annually.
Index fund managers tend to charge an expense ratio as low as 0.02% and as high as 0.2%.
Mutual fund managers, on the other hand, can charge a ratio ranging from 0.5% to 1%.
These are very rough averages though. If you do some research you may find either type of fund with a more competitive fee structure.
Whatever you go with here, remember that fees cut into returns. So choose wisely…
Risk
Index and mutual funds also differ in regards to the risk they carry.
Since index fund managers use a passive investment strategy to invest your money, they generally do as well as the broad market or an industry. They also won’t do much worse than them during the bad years.
Mutual funds are a completely different story though. Beating the market is an ambitious goal and it comes with the risk of doing much worse than it sometimes. We can’t emphasize enough how bigger the risk is when you invest in a mutual fund.
But of course, any reasonable person would also be looking at the potential returns they would be getting with either type of fund before they concluded what kind of risk they are willing to take.
Which brings us to the last index vs mutual fund difference…
Performance
The average historical performance for both index and mutual funds can differ wildly.
Most index funds will do well over the long-term, especially if they follow a broad-market index.
That’s not the case with mutual funds, however. On average, they tend to underperform index funds over time as we have already mentioned.
Their goal may have a part to play in this phenomenon. After all, beating the market is getting more and more difficult as an objective the more you stretch your investment horizon.
Besides that obvious disadvantage, mutual fund managers also charge higher fees for actively managing your money. That eats into your returns.
So, that’s another difference that you should take into account before deciding what fund you should go with.
Index vs Mutual Fund: So what should you Choose?
OK, so what should you select as your investment vehicle?
Well, after understanding all of the aspects that make index and mutual funds differ, you will be able to make an educated decision.
What are your priorities?
Go with an index fund if you want to:
- Follow a market or an industry,
- Not pay too much in fees,
- Take as less risk as possible, and
- Have a steady performance.
But select a mutual fund only if you:
- Want to beat the market,
- Can afford the higher on average fees,
- Are risk-tolerant, and
- Can stand the volatility.
If you decide to invest in an index fund, check out this step-by-step guide.
I hope this index vs mutual fund comparison was informative enough and helped you make up your mind about which you should go with. If it did, please make sure you share it with others!
And feel free to make a comment or ask anything below…
Disclaimer: This information should not be viewed as financial advice. You should consult a financial advisor or do your own due diligence before you invest. The owner of this website and author of this article are not to be held liable for any undesired result by anyone who uses this information that is provided here in any way.
