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.
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Source: Index Funds vs Mutual Funds (wallstreetmojo.com)
Both funds are a source of investment and are saved in subscribing to the units of the fund. Many funds possessing different characteristics and 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, mutual debt fund, hybrid mutual fund, index fund, exchange-traded fund, etc.
Index Funds vs Mutual Funds Infographics
Let’s see the top difference between index funds vs mutual funds.
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Key Differences
The critical difference between are as follows –
- The significant 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 an 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.
- Index fundsIndex FundsIndex Funds is a form of mutual fund constructed to replicate and match the performance of a particular country's index like S&P, NASDAQ, etc., and helps investors take broad market exposure due to the amount invested in various stocks of the different sectors of the economy.read more, which are the investment mix of the fund, are generally automated as it an 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 funds is mostly an active investment. In contrast, the mutual funds track the company or the share of the various stock in the industry and withdraw and invest their holding in beating 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 as the investment in this fund is passive investingPassive InvestingPassive investing is a strategy used by investors to maximize their returns by avoiding frequent portfolio churning by buying and selling securities and instead buying and holding a diverse range of securities.read more. 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.
Index vs Mutual Funds 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, 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 particular index and does not deviate their holding from that index. | It deviates from the benchmark and can invest in various stocks since they make active investments and are tracking the stocks. |
| Closed-Ended | Open-Ended |
| Short to the medium time investment horizon | Generally, the long investment horizon is useful when an investor is opting to invest in these funds. |
| Investment is in an index that purchases all the stock in the same proportion as of the index. | Investment is in stocks. There is no fixed 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. They do not incur a considerable expense in the selling and buying stock; hence their expense ratio is less than the mutual fundsMutual FundsA mutual fund is an investment fund that investors professionally manage by pooling money from multiple investors to initiate investment in securities individually held to provide greater diversification, long term gains and lower level of risks.read more. | It incurs a high cost in the purchase and selling of stocks, and hence the expense ratio of the fund is a considerable amount, which also affects the return of the fund. |
Final Thoughts
Whether to invest in the index or mutual funds is a question of the investment objective of the investor, and it also depends on the time horizon and the risk appetiteRisk AppetiteRisk appetite refers to the amount, rate, or percentage of risk that an individual or organization (as determined by the Board of Directors or management) is willing to accept in exchange for its plan, objectives, and innovation.read more of the investor. However, history has suggested that the return of the index fund has outperformed the recovery from the mutual fund. This is mainly because of the expense and the management fees, which are of significant amounts in 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 significant 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 light of the budget. Also, investor awareness about the new products in the market is critical for an investor who is actively looking for financial assetsFinancial AssetsFinancial assets are investment assets whose value derives from a contractual claim on what they represent. These are liquid assets because the economic resources or ownership can be converted into a valuable asset such as cash.read more to invest their hard-earned money.
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