Difference Between Index Funds and Mutual Funds

One of the most attractive tools of investment today is mutual funds. The reason they are called mutual is because of the participation of many people who pool together a sun of money that is managed by a company by investing in other companies in the share market as well as securities. It is based upon their past performances that people are getting more and more attracted towards these mutual funds. Index funds are a part of these mutual funds. They are a small proportion of the size of the total funds and are used by the portfolio manager to ascertain the returns from the market.

Index funds

As the name implies, index funds are used for indexing. This means that a miniscule part of the mutual funds is used to check the returns from various stocks coming from various sectors of the economy. This miniscule fraction of mutual funds is called index funds. There are many segments of any stock market such as banking, IT, metals, industrial, infrastructure, energy etc and each segment has its own index. S&P and Dow Jones are two popular companies that develop market indices.

Index funds are managed passively as the portfolio manager is merely trying to replicate the index rather than making any assumptions and trying to maximise the profits. Index funds are of varying sizes and some may include only a few stocks from the market while some may include nearly all the stocks of the market. Wilshire 5000 index is one index fund that includes all the stocks in the US stock market. S&P small cap 600 is an index fund that includes very small value stocks that are considered as growth stocks. Since these funds are not actively managed, the fee of investing in these funds is also very low as compared to actively managed mutual funds.

Mutual funds

As described earlier, mutual funds are the funds pooled by a large number of people that are invested in the share market by a company and the profits derived are shared among the members in the proportion of shares held by them. In true sense, a mutual fund company is a middleman between the end consumer and the share market as it charge fees for its expertise or the knowledge of the stock market and makes profit for the public that holds its shares. There are today more than 25,000 mutual funds in the world operating in different stock markets. Each mutual fund company has its own policies and guidelines which decide its direction and the manner of investment. Depending upon its goals, any mutual fund company invests only in those companies that are deemed fit.

The portfolio of any mutual fund company is diversified with stocks, shares, government securities and bonds that are a mix of risk and prudence. The primary goal of any mutual fund company is to reduce the risk to its share holders.

Difference between Mutual Funds and Index Funds

It is easy to see that index funds are a part of mutual funds and are used by portfolio managers of mutual fund companies to assess the trends in the market. They are able to judge the better performing stocks on the basis of index funds performances. Index funds are passively managed while mutual funds are actively managed. This only shows that index funds are used to replicate the performance of the stock market and do not need much of an expertise from the portfolio manager. This is why if you wish to invest in index funds, you are charged much less fees as compared to when you wish to enter an actively managed mutual fund.

However, there are many who invest in index funds also and earn a decent profit according to the movement of the market. There is a wider selection of stocks, or you can say diversified choice with a relatively low cost to the investor. As index funds are always a reflection of the market, investor gets higher returns when the market is upbeat. This is not so in the case of mutual funds which can give high returns to the investors even when the market is going down.