Index Funds vs. Mutual Funds What Is The Difference?

Index funds and mutual funds are cut from the same cloth. They’re both assets that invest in market-related instruments to generate returns for their investors.

However, index funds and mutual funds differ in terms of nuances like investment goals, management style, and differences in cost. Let’s go through these differences in-depth. 

What Is A Mutual Fund?

A mutual fund is a pool of money collected from several investors. Generally, there’s a dedicated expert who’s referred to as the “fund manager” that handles the finances of a mutual fund.  

The fund manager invests the pool of money in stocks, bonds, and other mutual funds with help from his team of analysts. That’s a mutual fund in a nutshell. 

Broadly speaking, mutual funds can be categorised as equity, debt, or hybrid mutual funds based on what they primarily invest in. For example, a fund that primarily invests in stocks is an equity fund. 

‍Read this blog to know which mutual funds can give the highest returns in 2021

What Is An Index Fund?

An index fund can either be a mutual fund or an Exchange Traded Fund (ETF). An index fund primarily invests in stocks and is handled by a fund manager just like a mutual fund.

However, the fund manager is not actively involved in the investment process. The reason behind this lies in the primary aim of an index fund. The goal of an index fund is to mirror an index like the S&P 500 or Nifty. 

Mirroring an index simply means that an index fund will invest in all the stocks that are a part of the stock index that it is tracking. For example, an S&P 500 fund will invest in all 500 of the stocks listed on the index. 

That’s why a fund manager isn’t actively involved in the day to day running of an index fund. This has wider implications on aspects like the expense ratio and even the returns that an index fund generates. You can consult a Cube Wealth Coach or download the Cube Wealth App.

Top Differences Between Index And Mutual Funds

#1. Active And Passive Fund Management 

Most mutual funds are actively managed while all index funds are passively managed. In this context, active and passive isn’t an indicator of grammar or lexicon. Let’s understand this in greater detail.

1. Active Fund Management

Actively managing a fund means that a fund manager will be involved in the everyday monitoring and stock or bond picking activities of a mutual fund. 

The fund manager will be backed by a team of analysts who’ll constantly monitor the market for buying and selling opportunities. This may lead to a better chance of generating higher returns. 

Thus, the expense ratio of actively managed funds is higher to compensate the fund manager and his team’s involvement. An expense ratio is charged when you exit any mutual fund, including index funds.

We’ve simplified important mutual fund jargon. Read the story here

2. Passive Fund Management

Passive fund management is just like earning passive income - invest once and let the investment work for you while making periodic tweaks. 

The Asset Management Company (AMC) of a passively managed fund, like an index fund, will replicate a stock index once and leave the portfolio on autopilot afterwards.  You can consult a Cube Wealth Coach or download the Cube Wealth App.

A passively managed fund will not have a team of analysts monitoring the market. In most cases, it may not even have a fund manager because the fund will simply track an index. 

That’s why the expense ratio of passively managed funds including index funds is known to be very low. The trade-off lies in the predictable returns that most index funds are known to generate.  You can consult a Cube Wealth Coach or download the Cube Wealth App.

#2. Investment Goals

Right off the bat, there’s one thing you should know about both mutual funds and index funds - they’re both designed to generate solid returns for their investors. 

However, the range of returns that a mutual fund generates varies from that of an index fund because of its individual investment goals. A mutual fund will generally aim to beat the market. 

An index, on the other hand, will look to mirror the index it is tracking. This difference may lie in investment goals but ties back to the point of active versus passive fund management.

Active funds, like several mutual funds, employ teams to analyse the market. Their goal is to identify winners that can generate market-beating returns. 

Furthermore, the fund management team has the leeway to do what’s best for the investment goal of the mutual fund. 

On the other hand, a passive fund is more laid back and its price will tend to fluctuate based on an index’s movement, mirroring it to the closest number possible. 

That’s all about mutual funds and index funds’ investment goals. But what about yours? Read this blog to know how to define your investment goals  

#3. Investment Cost 

An active fund is handled by a fund manager and their team. The Asset Management Company (AMC) will have to compensate the fund management team with a salary and other perks. 

As a result, actively managed funds carry a higher expense ratio and thus, are costlier for investors. Passive funds don’t have a fund management team because of which they are relatively affordable. 

Should You Invest In Index Funds Or Mutual Funds?

Proponents of passively managed funds like Warren Buffet have stated that retail investors can benefit from investing in index funds. That’s down to a few important benefits: 

• Vast exposure to multiple stocks
• No need to pick individual stocks 
• Relatively low investment cost  
  

However, top mutual funds like the ones on Cube can give you access to more hyper-focused categories of stocks and bonds that have the potential to outperform the market. 

In the end, whether or not you should invest in a solid index fund or mutual fund will depend on factors like:

• Risk profile
• Investment goals
• Portfolio health 
• Affordability 
  

Top Index Funds And Mutual Funds In India

The Cube Wealth app gives you access to the top index funds and mutual funds in India handpicked by Cube’s advisor, Wealth First, which has a track record of beating Nifty by ~50% over the past decade. 

#1. Top Index Funds In India

#2. Top Mutual Funds In India

Watch this video to find out how you can avoid a classic investing mistake

FAQs 

1. Is a 3-year SIP suitable for all types of investments?

Ans. A 3-year SIP may not be suitable for all types of investments, especially those with longer-term financial goals. It is best suited for short to medium-term objectives where you anticipate needing access to your invested funds in approximately three years.

2. What factors should one consider when choosing a 3-year SIP?

Ans. Factors to consider when selecting a 3-year SIP include your financial goals, risk tolerance, and the investment horizon. It's essential to choose mutual funds that align with your goals and have a history of consistent performance.

3. Are there specific mutual funds designed for a 3-year investment horizon?

Ans. While there are no mutual funds specifically designed for a 3-year horizon, you can select mutual funds based on their investment objectives. Debt funds or hybrid funds with a significant debt component are often favored for shorter investment periods.

4. What are the advantages of a 3-year SIP over other investment options?

Ans. A 3-year SIP offers a disciplined and automated approach to investing, which can help individuals achieve their short to medium-term financial goals. It provides an opportunity for wealth accumulation with lower volatility compared to equities.

Conclusion

A 3-year SIP can be an effective investment strategy for individuals with short to medium-term financial goals. It provides a structured and disciplined approach to investing in mutual funds, making it accessible to a wide range of investors. You can consult a Cube Wealth Coach or download the Cube Wealth App.

When selecting a 3-year SIP, it's crucial to consider factors such as your specific financial objectives, risk tolerance, and the investment horizon. You should choose mutual funds that align with your goals and have a track record of consistent performance.

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