In this article, we’re going to be talking about index funds vs mutual funds. What are the differences between them and how do they work?
You can think of a fun kind of like a basket of stocks. Instead of trying to find the perfect company to invest in, you can invest in a fund that gives you exposure to a whole bunch of stocks. So if you are investing as an individual company and the company goes bankrupt, now you will lose everything. This is where funds come in handy, the S Amp P 500, which gives exposure to the biggest 500 companies in the stock market.
Therefore, mutual funds are a way to reduce your risk by investing in multi companies instead of just one. Mutual funds are funds managed by a portfolio manager. Now, there will be a money manager who will invest your money for you in many different businesses.
Mutual funds have the highest fees because now you’re paying for a money manager to actively manage your money. So it’s not uncommon to see a mutual fund charge you between half a percent and two and a half percent in fees to manage your money. And this is money you have to pay every year on your assets, whether you make money or you lose money.
Some mutual funds will have minimums. They will say that you have to invest a minimum of say, $500 or $1,000 to invest in a mutual fund. But you’re also seeing other mutual funds lift a minimum requirement so they no longer have a minimum to invest. Now, depending on how you purchase your mutual fund, you might be able to trade it easily like stock or you might not be able to trade it so fast. If you buy a mutual fund directly from the investment company that’s issuing the mutual fund, you might not be able to trade it more than once a day.
But if you buy a mutual fund from a brokerage and this mutual fund is trading like a stock, well, then you’ll be able to trade it much easier throughout the day. Some of the biggest pros of a mutual fund is it allows you to diversify your money. So you’re not investing in just one company, you’re investing in a basket of stocks. And the second pro is you don’t have to find the best investment yourself. You have a money manager that’s working to invest your money for you.
But some of the biggest cons with the mutual fund is your fees are very high. The expense ratio on the mutual fund are a lot higher than the other funds because you’re paying for a money manager to actively manage your money. And the second con is many money managers cannot outperform the market year after year after year.
An index fund is similar to a mutual fund where it’s a basket of stocks that you can invest in. But unlike a mutual fund, it’s not managed by a person, it’s managed by a computer. So the fees with an index fund are significantly less. For example, you have index funds that give you exposure to the S Amp P 500, which is the biggest 500 companies in the stock market. If a company falls out of the S and P 500, it becomes smaller.
Well, then your computer will automatically kick that company out of your index fund and will bring in a new company. So your fees are significantly less. And now you can get exposure to the general stock market or an index in the stock market and pay less money in fees. Most index funds will have a minimum money requirement. Some index funds might require $1,000, some may require more, and some may require less.
But again, kind of like mutual funds, index funds require you to invest this money. But some index funds are starting to lift this minimum requirement. When you buy an index fund, you’re purchasing the price of an index fund at the close of the previous day because index funds are not actively traded throughout the day. So you don’t get to see the real-time prices the way you can stock. Some of the biggest pros in an index fund are, again, you get diversification because now you’re not investing in just one company, you’re investing in a basket of stocks. And it’s passive. You don’t have to manage your investments. You have a computer that’s managing investments for you. Some of the biggest cons with an index fund are, one, you’re limited to how often you can buy or sell your index funds. And second, many index funds do have a minimum investment, which means that you might not be able to buy into an index fund if you don’t have enough money to buy into it.
The goal of an index fund is often to match the market. When you invest in an index fund that gives you exposure to the general market, all you’re trying to do is get the returns of the market. When you invest in a mutual fund, your goal is to beat the market. But the risk with that is that many money managers will not be able to outperform the market, especially after you factor in the fees year after year after year.
If you’re not willing to put in the work to research companies, keep up with earning statements. You should not be investing in individual companies because now you’re not keeping up with the company. In your case, it’ll be much better for you to just invest in an ETF or an index fund. That way you can get the returns of the market without paying the higher fees. And the key for you to succeed with any of these strategies is you have to be investing your money for the long term and you have to consistently be investing your money whether the market is up or down. You want to stay consistent and you want to make sure that this is completely passive. That way, you stay investing your money consistently for the long term. That’s how you win in this game.