Index Funds And Mutual Funds Essay

1093 words - 4 pages

Personal finance and investing is just that: it's personal. From the day the first shares are bought, for the individual who surmises it's undertaking, the decisions made today will have everlasting impacts on not only the distant future of the investor but the investor's family for generations to come. Combine this with current uncertainty in the stock markets, housing markets and economy and you have effectively driven a wedge between the investor, his income and his family at large. Statistics abound in reference to how poorly managed the majority of American's finances are and it's no wonder with the abundance of securities that are available in today's markets.

Mutual funds and index funds have been triumphed as the "go to" investment vehicles for personal retirement savings and wealth building. In today's markets these securities are still very common and overall the performance and evaluation of index funds and actively managed mutual funds has come under scrutiny. By delving into the inner workings of these two securities with purpose of garnering further financial intelligence for the average investor, a comparison and contrasting of the two securities can be accomplished. Therefore, the following will be disclosed, dissected and detailed: the returns of actively managed mutual funds and index funds are historically similar in nature, the myriad of funds in the market provide varying degrees of risk and reward and that while managed funds typically have higher fees then index funds, each has been able prove over their individual abilities to achieve respectable gains and profitability over time.

Index funds and actively managed mutual funds have many similarities so for the purposes of clarification, definitions are provided below from the SEC. A mutual fund is "a company that pools money from many investors and invests the money in stocks, bonds, short-term money-market instruments, other securities or assets, or some combination of these investments." In comparison, the SEC defines an index fund as "a type of mutual fund whose investment objective is to achieve approximately the same return as a particular market index, such as the S&P 500 Composite Stock Price Index, the Russell 2000 Index of the Wilshire 5000 Total Market Index" (US SEC, 2008). By distinction of their very definitions a mutual fund is described as a pool of money from many investors while an index fund is merely a (significant) subset of a mutual fund. The main differences are brought to light when one considers each fund's objective, management style and return over time.

In the case of a managed mutual fund, the lead fund manager determines the goals of the fund. According to Stanford's Student Enterprise Investments Resource Center there are six basic types of mutual funds: equity funds (invested in stocks), fixed-income funds (invested in bonds), money market funds (MMF - reduced risk with low returns), balanced funds (a mix of the above),...

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