Difference Between Index Funds and Mutual Funds
Both the index funds and mutual funds are used to diversify the portfolio where the index funds are the closed ended funds that tracks generally the specific index without deviating their holding from it whereas mutual funds are the open ended funds that are managed actively which deviates from their benchmark by investing in the variety of the stocks.
Index funds and Mutual Funds are a source of investment and are saved in the form of subscribing to the units of the fund. A lot of funds possessing different characteristics and different strategies are in the market and investors can select from the pools of the fund to invest from.
There are different types of funds in the market like equity mutual fund, debt mutual fund, hybrid mutual fund, index fund, exchange-traded fund, etc.
Index Funds vs Mutual Funds Infographics
Key Differences
The key difference between are as follows –
- The major difference is that mutual funds investment objective is to exceed the benchmark return of the market or whichever funds of fund the mutual fund is investing in whereas, on the other hand, the investment objective of index fund is to maintain or match the return of the benchmark index for example to match the return of S&P index 500, etc.
- The index funds are mostly passive investing which is the investment mix of the fund is generally automated as it investment in the exact holding type as the index which is set as a benchmark index for the fund on the other hand investment of mutual fund is mostly active investment whereas the mutual funds track the company or the share of the various stock in the industry and withdraw and invest their holding to beat the return of the market
- The index funds track the performance of the index which is set as a benchmark whereas mutual funds track the performance of the various stocks which they have held and track the performance of their holdings
- Mutual funds are mostly open-ended funds whereas the index funds are close-ended and are generally have a lock-in period
- Index funds do not have a large management team when compared to mutual funds as the investment in this fund is passive investing. As a result, the fees which are lost in index funds are not in such a large amount of the return when compared to mutual funds which are actively managed and have a large investment team
Comparative Table
| Index Funds | Mutual Funds | |
| It doesn’t charge high fees as compared to mutual funds. | It charges high management fees due to active investing which is generally 2% of the asset under management | |
| History has indicated that the return of passive investment i.e. They outperform the returns of mutual funds. | These are easy to beat and outperformed when compared to index funds in practical. | |
| It generally tracks a very specific index and does not deviate their holding from that index | It deviates from the benchmark and can invest in a variety of stocks since they do active investment and are tracking the stocks | |
| Closed-Ended | Open-Ended | |
| Short to the medium time investment horizon | Generally, the long investment horizon is good when an investor is opting to invest in this funds | |
| Investment is in an index that is a purchase of all the stock in the same proportion as of the index | Investment is in stocks there is no fix proportion of stock investment and they invest in stocks according to the performance of the company or the intrinsic value of the stock | |
| It incurs less expense as compares to mutual funds they do not incur a large expense in the selling and buying of stock hence their expense ratio is less than the mutual funds | It incurs a significant cost in the purchase and selling of stocks and hence the expense ratio of the fund is a significant amount which also affects the return of the fund |
Final Thoughts
Whether to invest in index funds or mutual funds is totally a question of the investment objective of the investor and it also depends on the time horizon and the risk appetite of the investor. However, history has suggested that the return of the index fund has outperformed the return from the mutual fund. This is mainly because of the expense and the management fees which are of significant amounts in the case of mutual funds.
In India, the exposure to index funds is less when compared to mutual funds and also other developed markets. But in developed economies like the USA index fund has recently become a major source of investment and return and a lot of investors have been lured into this scheme by active fund houses. Investment options should be weighted in the light to the budget and also investor awareness about the new products in the market is also a key for an investor who is actively looking for financial assets to invest their hard-earned money in.
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