Mutual Funds vs. Index Funds

If you are planning to invest, particularly if you have never done so in the past, it may be important to learn the differences between mutual funds and index funds. You may have the opportunity to invest in both of these through your employer and choosing the best one will depend on a number of factors. In understanding index funds you will also need to understand a bit about the stock market indices.

Stock market indices are used to measure the value of stock groups. Index funds are mutual funds that often mimic the performance of stocks in the market index. Index funds share values are typically based on the net value of the stocks that they are invested in, much like mutual funds. However, instead of the holdings being purchased and then sold through trades, index funds change investments based on specific changes or rules of committees. Many studies have shown that index funds perform much better than mutual funds in many cases. Typically, they have much lower management fees because they are not actively being managed like mutual funds. They also trade less which gives them a much lower turnover ratio. This in turn gives them a lower capital gains tax. Many investors prefer index funds to mutual funds because they look much better on comparison. Before you purchase index funds however, it is important that you take the time to look into their history to ensure that they have been managed correctly.

Your specific employer may actually not offer you a choice between mutual funds and index funds. In this case then you should simply take the option that you are offered. Most companies today offer 401K or other retirement savings plans and some do offer both index and mutual fund options. Many times actively managed mutual funds have higher payouts than index funds, but again this may vary greatly from company to company. It is important that you take the time to learn more about the specific options offered to your through your employer before you choose.

Mutual funds also provide a number of advantages, not the least of which is their diversity. They offer you the ability to add to your investment portfolio with a minimum investment, which is important for many consumers. They also allow you to spread your initial investment among many different securities which in turn helps to lower your overall risk. Mutual funds are also managed professionally which is important for many consumers. They offer much more convenience than many other investment options. You can purchase, sell and change your distribution options using a variety of communication variations. Most can now perform needed tasks in person, by mail, online or by telephone. Mutual fund shares are liquid. This means that you can purchase or sell them only during market hours and the value of the funds are typically not determined until closing of business. Any commissions or fees that you may incur may not be determined until after you have purchased.

You can normally purchase a mutual fund for as little as $50 per month in some cases and many can be purchased for less than $1,000 total. You have the option of investing a specific dollar amount every month or every quarter. This however may depend on your employer so be certain that you check to see when and how much you can invest or the minimum that you must invest in order to purchase. Determining which is best for you regarding mutual funds vs. index funds will depend on your employer’s options as well as your personal preferences. Take the time to learn more about each investment opportunity to ensure that you fully understand the risks involved and the requirements for investing. If your employer offers both options then simply choose the one that you feel will best fit your future financial needs.

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  1. One of the the several advantages of mutual funds, I think, is that if a fund is managed by managers with excellent expertise, the return is predictable.