Skip to main content
Message Font: Serif | Sans-Serif
 
No. of Recommendations: 0
Hola Fools,
I have been reading in your site about mutual and index funds, but I am unclear (even with explanations from friends and more reading)as to the bottom-line definition of each and the differences. Also, are there other terms used to mean index or mutual funds?
Appreciate all you guys do.
Print the post Back To Top
No. of Recommendations: 1
<<Hola Fools, I have been reading in your site about mutual and index funds, but I am unclear (even with explanations from friends and more reading)as to
the bottom-line definition of each and the differences. Also, are there other terms used to mean index or mutual funds?

Appreciate all you guys do.>>

A question I hear all the time. I'll try to make this as simple (and painless) as possible.

Have you ever heard of the S&P 500 or the Dow Jones Industrial Average?

Each of them is an index. These indicies (plural of index) are concocted by someone to represent certain segments of the economy. It is not so important to know how they go about this. What is important is that you understand that certain companies are picked to be a constituent of an index (kind of like picking players for a baseball team). Now think of the value of the index as the team's batting average. You get the team's batting average by averageing in the batting averages of the individual players. In an index, you average the price of the stock of the companies that make up the index. So, what is an index fund? A fund that invests in the companies that make up the index to such an extant, so that the fund's returns will closely miror the returns on the index. So, if you buy into an S&P 500 index fund, your returns should closely resemble that of the S&P 500 index.

Ok, think of a mutual fund as a fund that need not put its money into any particular stock in any particular index. But, the mutual fund will pick a large selection of stocks, generally, to reduce risk. Different mutual funds have different investment plans and objectives. Some will invest in most tech stocks, some in foreigh stock, etc. Here the investment manager of the fund has wider discretion as to what he buys for the fund as his investments will not be tied to a particular index.

Now why invest in one rather than the other, I'll save that for another post, or you can email me :)

Fool On!
D.P.
Print the post Back To Top
No. of Recommendations: 0
kbuena,

I think the previous post does a great job of giving a good definition for each.

But, the biggest differences between index funds and nutual funds are:

Generally -
Index Funds: Usually have lower or no costs to invest into the fund, maintain the fund in and get out of the fund. Usually called "no-load" funds if no % fees are charged for getting in and out of the fund. There are smaller maintenance fees since no one is getting paid to choose which stocks/bonds/etc. the fund invests in. They just simply follow what stocks are in the indicies.

Mutual Funds: Generally have a fee ("load") to pay to get in or out or both of the fund. Plus, there are usually higher fees charged to maintain the fund since there are people higher to decide what stocks/bonds/etc. to invest in.

Most importantly way too many mutual funds never beat the average returns of the index funds, because the managers make poor choices in the market.

Hope this helps.

If you have more questions you might want to go to the Mutual Funds board:
http://boards.fool.com/Messages.asp?id=1030021000000000

or

Read more about Mutual Funds in general at The FoolSchool on Mutual Funds:
http://www.fool.com/school/mutualfunds/mutualfunds.htm

Fool On and Happy Hunting,
tangerine
Print the post Back To Top
No. of Recommendations: 0
Try `The Index Fund Solution' by Richard Evans ($25) published by Simon and Schuster. An easy read which contains the answers to almost any question on the subject of index funds.
Print the post Back To Top
No. of Recommendations: 0
Index funds have cost advantages ;

i) they are passive leading to low management fees (.2% vs. 1-2% for managed funds)

ii) trading costs are low due to infrequent trading (.25% vs. 1.25% for managed funds)

iii) cash drag (i.e. losses due to the necessity of holding cash - typically 5% for a managed fund) is minimized

iv) there are favorable tax consequences associated with fewer transactions

v) active (large block) trading affects price adversely (for them).
Print the post Back To Top