Understanding Mutual Funds

A mutual fund serves as an instrument that operates with pooled money brought forward by investors. This pooled fund is invested in the stock market in assets that range from stocks and bonds to other financial instruments. Actively managed mutual funds invest money by a fund’s objective using the expertise of a fund manager. Conversely, passively managed funds merely replicate an index or benchmark.

Investing in mutual funds gives you access to diversification. Different mutual funds have different objectives depending on the investor's needs. Before investing in a mutual fund, it is essential to remember that they are subject to market volatility.

Understanding Index Funds

Index funds are a kind of mutual fund replicating a certain benchmark or index. Stocks from the same sector are shelved together under a given index that helps highlight a market sector.

Since Index funds passively mimic a benchmark index, they aim to generate similar returns. Their fund managers do not actively choose stocks but follow the benchmark composition. In India, index funds are available as exchange-traded funds (ETFs) and mutual funds, with ETFs traded on the stock exchange and mutual funds offered by fund houses.

Tabulating Differences Between Mutual Funds and Index Funds

The table below discusses the differences and similarities between mutual funds and index funds.

*Differences*
*Area of Consideration*	*Mutual Fund*	*Index Fund*
Investment Objective	These funds seek to surpass the investment returns of a related benchmark index.	These funds wish to mimic the investment returns of a benchmark stock market index.
Management Style	An active management style is followed, and fund managers and their analysts help select fund holdings.	A passive management style is followed, and the investment mix is automated such that the holdings of the benchmark index can be matched perfectly.
Operating Costs	Mutual funds incur greater expenses as fund managers need extra costs to conduct extensive industry research with regularity.	Given that these funds are passively managed, they have a more affordable expense ratio.
Selecting a Fund	Investors need to conduct extensive research before selecting a mutual fund. They need to take into account several factors like the fund manager’s historical returns, the total assets under management, past returns etc.	Since index funds simply track an index, their returns are ordinarily in sync with the index. Deciding which index fund to invest in simply requires lesser research as you only need to consider the fund’s expense ratio and tracking error.
Risk	Here, risks are largely linked to the market capitalisation of the fund’s holdings.	Risks are primarily dependent upon the underlying index.
Flexibility	Mutual funds provide investors with a greater degree of flexibility. Further, fund managers are entitled to hedge fund portfolios in unfavourable situations.	There is limited flexibility under index funds as the fund must follow a given index. Since index funds are passively managed to simply mimic an index, they can’t be hedged in unfavourable circumstances.

Final Thoughts

Now that you have read this article, you should be able to answer the question, “Is an index fund a mutual fund?” and know that index funds serve as a kind of mutual fund. Deciding whether index funds are the most appropriate mutual funds for you to invest in ultimately depends upon your investor profile. Your financial goals, your threshold for risk, the amount of money you are willing to put in and the time frame you are eager to devote to investment are all critical factors when finding the right fund. And if you’re looking to begin your investment journey, select the right kind of funds and check out Fi.

Frequently Asked Questions:

1. Are index and mutual funds the same?

Index funds serve as a kind of mutual fund; however, not all are index funds.

2. What advantage do index funds have over mutual funds?

Some advantages that index funds have over mutual funds are as follows.

They have a lower expense ratio.
Since they are passively managed, the fund manager’s fees are lower than other mutual funds.
You don’t need to conduct ample research or be aware of the intricacies of investing before choosing to invest in an index fund. Conversely, you need to do ample research on a mutual fund to determine whether it is appropriate for you or not. Factors to consider are the fund manager’s historical returns, the total assets under management and past returns.

3. Are index funds riskier than mutual funds?

No, other mutual funds are riskier than index funds since they work to try to beat the market. Index funds simply wish to mimic a benchmark, providing slow but dependable returns over time.

4. What are the 2 cons of investing in index funds?

Two shortfalls associated with investing in index funds are as follows.

Index funds are vulnerable to tracking errors. Since they replicate an index or benchmark, the deviation of returns by the funds according to the index can be risky.
You aren’t given a choice regarding where a fund invests your money.

5. Why are index funds better?

Index funds are considered better for several reasons. Firstly, they offer broad market exposure by tracking a specific market index, such as the S&P 500, allowing investors to diversify their holdings across various companies. Secondly, they have lower expense ratios than actively managed funds, which can eat into investment returns over time. Lastly, they have historically shown competitive performance due to their passive investment approach and lower costs.

6. Is index fund low or high risk?

Index funds are generally considered low-risk investments since they aim to replicate the performance of a specific market index and provide broad diversification across multiple companies and sectors, thus reducing the impact of any individual stock's performance on the overall fund.

Index Fund vs. Mutual Fund: What's the Difference?

Summary