We do not manage client funds or hold custody of assets, we help users connect with relevant financial advisors. “An index fund would be best for someone who did not have a lot of money and was just starting to invest,” says Josh Simpson, gift planning officer at Kansas State University Foundation. “This would allow them to achieve diversification with their investment without having to spend hours learning how to invest.” If you’re ready to get started, check out the SmartVestor program. We can connect you with up to five investment professionals to choose from.

Key differences between actively managed mutual funds and index funds

This strategy relies on the fund manager’s skills, insights and expertise. Unlike regular mutual funds, you cannot customise an index fund or hand-pick individual securities. This is because index funds are passively managed, with the primary goal of mirroring a market index’s performance. This approach may lead to a tracking error, meaning a potential difference between the fund’s performance and that of the market index. Most mutual funds are actively managed, which means they have a team of professionals working behind the scenes picking and choosing the stocks, bonds or other investment options to include inside the fund. The goal is to put together a collection of stocks that outperform the average stock market index.

• “The reason someone would choose an actively managed mutual fund is that if one can identify a fund manager that can consistently beat the market, one can accrue tremendous wealth,” says Johnson.
• Selecting an actively managed MF requires a thorough analysis of factors such as the fund manager’s past performance, AUM, and historical returns.
• The decision revolves around whether investors prioritize consistent returns and cost-effectiveness (index funds) or seek potential outperformance and active management strategies (active mutual funds).
• While this opens the door for higher potential gains than index funds, it also means returns might lag the index.

Working with an adviser may come with potential downsides, such as payment of fees (which will reduce returns). There are no guarantees that working with an adviser will yield positive returns. The existence of a fiduciary duty does not prevent the rise of potential conflicts of interest. SmartAsset Advisors, day trading patterns LLC (“SmartAsset”), a wholly owned subsidiary of Financial Insight Technology, is registered with the U.S. You can make informed investment decisions once you understand the differences between Index Funds and Mutual Funds.

You’re our first priority.Every time.

Let’s say you’re making a one-time $10,000 investment in a mutual fund or an index fund, and your plan is to let the money sit and grow for 30 years. With help from a financial advisor, you find a mutual fund using an advisor and paying a 1% annual fee, an ongoing 0.47% expense ratio, and a 13% average annual rate of return (yes, they exist!). Both index funds and active mutual funds are managed by professional investors—typically through an asset manager—even if the fund doesn’t require a lot of day-to-day activity. In addition to brokerage fees and expense ratios, tax efficiency is another factor to consider when choosing between index and mutual funds. Over time, even a small difference in expense ratios can make a significant impact on your investment returns.

These aim to outperform the market, providing the potential for higher returns. Another difference is the investment objective each type of fund offers. With index funds, the goal is to simply mirror the performance of an index, while with a mutual fund, the objective is to outperform the market. Essentially, actively managed funds strategically select investments that will yield a higher return than the market. Both index and active mutual funds can help you achieve your financial goals, but through very different approaches.

Index Funds vs. Mutual Funds: What’s the Difference?

New investors often want to know the difference between index funds and mutual funds. The thing is, sometimes index funds are mutual funds and sometimes mutual funds are index funds. It’s like asking about the difference between apples and sweet food.

Understanding the cost of investing is crucial when deciding between index funds vs mutual funds. Let’s talk about brokerage fees, expense ratios, and their impact on your investment returns. Choosing between index funds and mutual funds can significantly impact your investment returns.

How we make money

Simply put, mutual funds are investments that allow investors to pool their money together to invest in something—usually stocks or bonds. Whether it’s the pros doing it or individual investors, active management tends to lead to underperformance. Passive investing is an attractive approach for most investors, especially because it requires less time, attention and analysis and still generates higher returns. To say it another way, investors can buy an index fund that’s either an ETF or mutual fund. They can also buy a mutual fund that’s a passively managed index fund or an actively managed one.

Bankrate.com is an independent, advertising-supported publisher and comparison service. We are compensated in exchange for placement of sponsored products and services, or by you clicking on certain links posted on our site. Therefore, this compensation may impact how, where and in what order products appear within listing categories, except where prohibited by law for our mortgage, home equity and other home lending products. Other factors, such as our own proprietary website rules and whether a product is offered in your area or at your self-selected credit score range, can also impact how and where products appear on this site.

Differences Between Index Funds and Actively Managed Funds

While this can result in higher gains, there is also a risk that the fund could underperform. Index funds are a type of investment that tracks a specific market index, like the S&P 500. They are passively managed, meaning they don’t require a fund manager to pick stocks. Instead, they aim to match the performance of the index they follow. This makes them a low-cost, low-maintenance option for investors.

Since actively managed mutual funds trade more often than passively managed index funds, active mutual funds typically incur more taxes. If your goal is steady, long-term growth with minimal effort, index funds are often the better choice. These funds track market indices and offer predictable returns with low involvement from investors. They are ideal for those looking for broad, diversified exposure without the need for active decision-making. Alternatively, if you are seeking higher growth and are willing to accept more risk, actively managed mutual funds may be more appealing.

When should you pick an index fund vs. active mutual fund?

But what’s the real difference, and how do brokerage fees play a role? Whether you’re a beginner or a seasoned investor, understanding these two popular investment options is key to making smart financial decisions. Index funds tend to have lower fees due to their passive nature, making them more cost-effective for those focused on minimising expenses. Actively managed mutual funds usually ask for higher fees than passive funds, which can erode returns over time, though they might attract investors willing to pay a premium for the potential of higher gains. Actively managed mutual funds involve fund managers actively selecting assets and adjusting their allocations based on research and market trends.

Passive Management (Index Funds):

However, if you’re comfortable with higher volatility and want to chase higher returns, mutual funds could be a better choice. A mutual fund combines the funds of investors who mutually pool their monies to buy and sell securities. Investing in a mutual fund is not trading shares of specific companies held by the mutual fund.

Instead, it is trading shares of the mutual fund company itself. Investors buy and sell their stakes in mutual funds at a price set at the end of a trading session – their value does not fluctuate throughout the trading session. While the choice depends on your investment goals and beliefs, index funds are often considered the better option for long-term investing because of the lower fees and historically better performance.

• It is good to invest in Index Funds if you want low costs and consistent returns with minimal risk.
• Active mutual funds are managed by professional fund managers who aim to outperform a specific benchmark or market index.
• Again, passive investing beats active investing most of the time and more so over time.
• The broad stock market might be up while an active mutual fund is down, for example, although the opposite can also occur.
• That doesn’t make a lot of sense, and it can ring up capital gains taxes, if the fund is held in a taxable account, as well as fees for early redemption of your mutual fund.
• Studies indicate they tend to outperform actively managed funds over 80% of the time, especially in bearish markets.

While this can lead to higher returns, it also comes with higher fees. Index funds and active mutual funds both charge an annual expense ratio to compensate the manager overseeing the fund. The fee for investing in a passive index fund tends to be substantially lower than active funds. Still, in both cases, you wouldn’t owe this fee if you built the same investment portfolio yourself, though you could encounter trading fees on your own.