Investing
What is the difference between a managed mutual fund and an index mutual fund? Why should you care?
What is the difference between a managed mutual fund and an index mutual fund? Why should you care?
A managed mutual fund has one person or committee in some cases who buy and sell securities (stocks and bonds in most cases) using all kinds of approaches so they can beat others who are trying to do the same thing. They attempt to time the market, be in the right sectors at the right time and ultimately, “outsmart” their counterparts on Wall Street. All of this activity and people can cost a great deal of money. The average managed mutual fund averages around 1.2% per year and that cost is compiled in a thing called the expense ratio.
An index mutual fund has no one managing the fund. It simply buys the entire index of securities. The S&P 500 Index Fund is a good example. This type of fund will own all 500 of the largest companies in the world that make up the index in relation to their size. No one tries to time the market or figure out what is undervalued, overvalued, or simply ignored. They own the entire market in this instance (the S&P 500 makes up about 75% of the U.S. market, the remaining 25% includes small and mid size companies and could be owned in a Total Stock Market Index Fund). These funds tend to be very cheap. On average you should be able to pay an expense ratio of less than .10% to own them.
Why should you care? Managed funds consistently underperform index funds and it is primarily due to cost. Basically, someone else gets wealthy off your money instead of you when you select a bunch of managed funds over a small list of index funds. The research has been in for decades and people like John Bogle, Charles Ellis, Burton Malkiel, Daniel Solin, Rick Ferri, William Bernstein, David Swensen, Jack Meyer, William Sharpe, Paul Samuelson, Daniel Kauneman, Eugene Fama, Merton Miller and some guy by the name of Warren Buffett have been telling us what to do all along to grow our accounts instead of someone else’s. Own low cost index funds that own entire markets. Feed them every month. Rebalance on occasion (usually selling stocks and buying bonds because the stocks have gone up so much that you have a more volatile portfolio than you signed up for) when necessary to reduce the risk of the portfolio. Ignore the media. Ignore the pundits, Ignore Uncle Joe. Finally, as John Bogle would tell us, STAY THE COURSE!