The Difference Between Index And Mutual Funds

A robot reading a stock investing book.
Robot read this article and learned how he could get retire sooner with index funds.

Index funds are a type of mutual fund that invest in an assortment of individual stocks. They are controlled by a manager that buys and sells investments in an attempt to earn you the most money.

What makes an index fund different is that there is no manager doing any buying or selling. Instead of having an active manager they contain stocks that are already grouped together. You've probably heard of some of these groups already. Some of the most popular are:

  • Dow Jones
  • Nasdaq Composite
  • S&P 500
  • Russell 2000
  • Wilshire 5000

Are Mutual Or Index Funds A Better Investment?

Index funds are a better investment than actively managed ones. There are two reasons for this.

1. They Are Cheaper

Both charge a yearly fee called the expense ratio. A typical expense ratio for an actively managed investement is 1%, but expense ratios for an indexed investment are typically .5% or much lower. One like the Fidelity 500 (FXAIX), which mimmicks the holdings of the S&P 500, has an expense ratio below .02%.

If the difference doesn't seem like much to you the chart below will show you how expense ratios are devastating your brokerage account.

A chart showing how much expense ratios erode your investment returns.
$68,920 is an astonishing amount to pay in fees!

2. Most Managers Can't Outperform Them

They're actually so bad at their job that more than 60% of them can't outperfom the S&P 500. So not only do they underperform the market but they charge you higher fees for doing so.

The Best Low Cost Mutual Funds

The best low cost funds are at discount brokerages like Fidelity, Vanguard, and Charles Schwab. Your best bet is to invest in the S&P 500 and pay the lowest fees possible. Here are a few options:

If you're buying a mutual fund there is one other fee to look out for, it's called a load. Typically index funds don't have have a load but I wanted to point it out so that you don't end up paying one if open an account at an oddball brokerage.

Updated Jul 05, 2019 by Scott