Every investor aims to put money in the safest and highest return-giving investment instrument. However, investments cannot be this ideal and one needs to choose his position in between the two. It is likely that in order to churn higher returns, the investor has to take a fair bit of risk. Whereas, if he decides to play safe, the returns might not be exceptional. Index funds and Mutual funds are two such options where an investor can put money to play between his risk appetite and returns target.
Investment in index and mutual funds should be planned properly.
Although both the index funds and mutual funds fall under the same category of investment (in a broader sense), there is a lot of difference between the two on various parameters. Investors also strategize their investment portfolio based on the same. Here we will try to understand the meaning of both index funds and mutual funds and index fund vs mutual fund to frame the right investment plan.
Index Funds
Index funds are special types of mutual funds, which try to mimic specific benchmark indices. In index fund vs mutual fund, index funds aim to give market returns at a lower cost as compared to mutual funds. These are passively managed funds, in which the fund managers don’t choose stocks to invest in as per their discretion, instead, strive constantly to keep the same composition as that of the index under which it is based.
Mutual Funds
Mutual funds, on the other hand, are actively managed funds in which the fund management team decides the holdings/portfolio at their discretion. Mutual funds aim to generate returns equal to or greater than the market. In the comparison of index fund vs mutual fund, the latter is costlier. Unlike index funds, mutual funds invest in a variety of assets like stocks, bonds, and other types of financial instruments as well. They are professionally managed funds and come in several classifications based on the type of holdings, sectors in which the funds are invested, etc.
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Points to Keep in Mind While Choosing Between Index Fund and Mutual Fund
Cost
If you are looking for cheaper funds to invest in, index funds can be chosen over mutual funds. The expense ratio for index funds is less when compared to the same of mutual funds. The expense ratio in index funds is between 0-2 percent, whereas, it can be up to 2.5 percent in the case of mutual funds.
Risk
Mutual funds offer higher returns as compared to index funds. Since mutual funds are actively managed by professionals, they aim to generate equal or higher returns than the market. On the other hand, the returns from index funds are more or less equal to the returns generated by the market index as the ultimate goal of index funds is to mimic the market index only.
Reward
When it comes to the risks involved in index fund vs mutual fund, index funds are generally safer than mutual funds. This is because the aim to generate higher returns than the market in mutual funds also brings greater risk.
Attention Needed
Mutual funds require a fair bit of monitoring as they are based on the types of assets, sectors, etc. So if the investor feels that this particular type of asset or sector (the type of mutual fund) is going to generate negative returns or returns not as per the investor’s expectation, he might need to withdraw his investments and invest in some other mutual fund which can generate better returns.
Index funds, however, tend to follow the market index on which it is based. Hence, the objective of the investor is pre-decided, which is being satisfied with the returns generated by the market. So, in index fund vs mutual fund, index funds require little monitoring.
Long-Term Investment
It is seen that almost all major market indices have grown over time, irrespective of the growth of particular sectors that they represent. Although market indices may give negative returns in the short term, the chances for generating profit are high in the long term. Hence, if you are considering a long-term investment with no fixed goal for returns, index funds can be a safe and good choice to go for.
Goal-oriented Investment
Investment in mutual funds is often goal-oriented. And since they offer higher returns than index funds as well as carry more risk, investors, generally, withdraw the returns made after their goal is accomplished.
Research by Fund Managers
Mutual funds require extensive research by fund managers as the goal is to generate higher returns. The fund management team explores options continuously to find the better option. Whereas, the fund manager of index funds tries to keep the fund’s composition as similar as possible to the index which is being followed. So the best mutual funds are decided based on the best holding, and the best index funds are the ones that can follow the respective indices perfectly. Investors can plan their investments accordingly.
Composition
Investors, while choosing between index fund vs mutual fund, should keep their investment goals in mind. Index funds and mutual funds have very different organic compositions, which is very crucial for a wise investor to take into account.
Both index funds and mutual funds are popular investment options but the decision of best between index fund vs mutual is entirely subjective and depends on individual investor’s goal, risk appetite, and return expectations.