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Index and Mutual Funds – Key Differences

While an index fund and a mutual fund may appear identical on the surface, there are numerous key differences between them that might be vital to your retirement portfolio. Both index funds and mutual funds diversify assets, and they are typically invested in a basket of stocks that aims to meet certain investment goals.

Overview of Index Funds

An index fund tracks a certain list of securities, such as the Dow Jones Industrial Average or S&P 500 indexes, based on certain criteria. The Dow Jones index tracks 30 blue-chip (some of the largest companies in the country that are important to the United States economy) industrial and financial companies in the United States. The index is used by the media to gauge the economy and stock market as a whole.^[1] There are many other indexes that track different stocks or securities and have different criteria for companies to get added or dropped from them.

An index fund is an investment product that offers you the opportunity to buy a basket of stocks that tracks an index. Index funds may hold stocks tracked on an index, but often vary in how each stock is weighted. Sectors or stocks may be screened out or favored in certain technical or fundamental ways to achieve a specific investment goal.

Overall, Index funds simply track the market in some form or another with less of a focus on “beating” the market.

Mutual Funds Are Different Than Index Funds

An investment manager can select a variety of securities to invest in via mutual funds. Index funds are often less costly than mutual funds, but they offer a wider range of opportunities. In addition, a mutual fund’s objective is to meet a specific investment goal and outperform the market. Therefore, mutual funds are actively managed funds, whereas index funds are passively managed, altering only based on stock indexes, not manager decisions.^[2]

In general, index funds outperform mutual funds over the long term, especially when fees are taken into account. However, those fees may be worth it when specific investment risks are covered, and goals are met. In addition, you may benefit from increased diversification and flexibility.

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[1] https://www.investopedia.com/investing/what-moves-the-djia/
[2] https://www.nerdwallet.com/article/investing/index-funds-vs-mutual-funds#

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