All savvy investors tend to invest in markets to earn the highest potential returns on their investments. However, investing directly in markets can be extremely risky because of the volatility of the market. To have a certain amount of cushioning against this volatility, it is recommended that the investors take the route of mutual funds. These funds are managed by professionals who have a better understanding of markets and can manage their volatility better. Now there are different types of mutual funds like equity, debt, balanced etc. and then there are index funds.
Today we will make a comparison between index funds and mutual funds and see which comes out as a winner in this index funds vs. mutual funds comparison. Though both are investment instruments, there are some major differences between the two. These differences are in:
The objective of an index fund is to match the investment returns of a particular stock market index, which can be NIFTY 50, SENSEX etc. The portfolio of these funds imitates that of the benchmark index and the fund manager delivers the returns that are nearly equal to that of the benchmark index. At times, the investor finds some difference between the performance of the index and the fund and this difference is known as tracking error. It’s the job of the fund manager to keep this error to the minimum.
The mutual fund, on the other hand, works at the sole objective of beating the index. There are many types of mutual funds keeping in line with the risk appetite of the investors. For instance, the equity funds fall under high-risk high gain while the debt funds are relatively safe but then returns are also subdued.
The mutual fund requires active management with fund managers taking decisions even on an hourly basis when there is huge volatility in the market. It’s the fund manager along with its management team that takes decisions in case of mutual funds. They are free to find their value picks across indexes and also across various investment instruments like stocks, bonds, securities etc. All they need to adhere to is the fund’s stated charter.
The index funds do not require active human oversight and hence follows a passive management style. Here the portfolio performance is based on the price movements of the individual stocks that are listed on a particular index. The picking of stocks is also non-negotiable as whatever stocks are there in the index need to be in the fund too.
There is a cost factor involved in managing funds like salaries of employees, their benefits, bonuses, office space etc. This cost is to be paid by the investor. This cost is approximately 1.5-2% in case of mutual funds while for index funds it is around 0.5%.
These are the three main differences when comparing index funds vs. mutual funds. Both have takers in the market and which one a person will opt for depends on their goals and preferences.