Morning! Today I welcome back Derek Sall from LifeAndMyFinances.com, for the third installment of our investing series. You can check the first post, Investing-What is the point? where Derek talked about the importance of investing, even in small amounts, and how to start investing, where he reviews the costs of different brokerage accounts. Today, Derek compares mutual funds and index funds. Enjoy!
Are you an investor? Do you often put money away in order to have a better future? If so, then I would assume that you’ve heard of a mutual fund, but what about an index fund? Many people have not and quite frankly, they are missing out on a potentially profitable investment.
The Mutual Funds
While I’m certain that you’ve heard of a mutual fund, do you really know what it is? In the simplest terms, a mutual fund is a combination of many like-stocks and are put together in a single fund for you to invest in at a reasonable price (since you and other investors mutually share in the overall cost of this assortment of stocks). Within one single mutual fund, there may be an assortment of over 30 different stocks. If you did this on your own, it would likely cost you over a thousand dollars to buy just one share of each of these stocks (and that’s not including all the transaction fees either). Mutual funds are a great way to diversify your investment among many stocks at a relatively low price per fund share.
The Index Funds
Mutual funds help you diversify various stocks into common industries such as retail companies, real estate firms, or maybe even an assortment of oil refineries. Index funds have the same premise, but are slightly different in nature. Instead of investing in various related stocks, index funds actually model their funds after various indexes, like the DJIA, NASDAQ, or S&P500. I am currently investing in an index fund that has each of the stocks that the S&P500 does. So, if the S&P500 goes up, then I can be confident that my investment went up too.
Investing in Index Funds is incredibly simple (just like mutual funds). All you have to do is search for “Index Funds” within your online brokerage account. There should be many to choose from.
Once you find all of the index funds that are available, you will be happy to note the fees that are associated with these funds (because they are nearly 0% in many cases). Mutual funds often charge fees from 0.5% to 2% or more. You’ll most likely never seen an index fund that charges a fee of more than 0.5%, which will most likely save you thousands of dollars over your investment life.
The next question that you might be asking is, “Well yes, Index Funds might be cheaper, but do they earn as much money as a mutual fund? After all, I would be willing to pay more of a fee if the mutual fund earned me twice as much.” There are some mutual funds that perform very well, but over the course of time, the average mutual fund does not perform as well as the general stock market indexes, which means that the index fund (while cheaper) still outperform many of the best mutual funds out there.
It’s obvious that I am a fan of index funds, but even if you don’t believe me, take a look for yourself! Check the top mutual fund earnings over the course of 10 years and then compare those earnings to that of the index funds. Chances are, the index funds will come out on top.
Where do you invest? Index or mutual funds?
This post was featured on the Money Rebound, A Carnival with a Money Color, Carnival of Passive Investing, thank you!
I personally just buy individual stocks at the moment but for the wifey I have her in mutual funds. I am just starting to read up on index funds but would like to learn more but just jumping in and picking something. The principles seem the same as mutual funds so it should be any harder. The key is just doing something and sticking with it long enough to see good results.
Thomas | Your Daily Finance recently posted…Watch Your Wallet – Saving money and losing weight
I invest my 401k in a few different mutual funds. I don’t pay too much attention to it, but I have it allocated across three different funds. I think the most important thing is to make sure you keep putting money into it, versus what funds you use.
DC @ Young Adult Money recently posted…Tips on Dealing with a Difficult Manager
I think index funds are 100% the way to go. The evidence is just so overwhelmingly in their favor. It honestly sometimes boggles my mind that people do it any differently.
Matt Becker recently posted…The Mythical $12,000 Baby
I think both can be good to use, depending on what your needs/goals are. That’s a huge key though that many overlook – knowing what your needs and goals are. The important thing to remember though, is that there are quite a number of index funds out there on indices that have either not been around long or unproven (or higher in fees) and thus not necessarily a good thing to be in. As with anything in investing, the key is to doing your research and finding what fits with what your need is.
John S @ Frugal Rules recently posted…What’s a Favorite Thing That Money Has Allowed You to do?
I would add that Index funds should generally be considered as longer term investments and will likely give you the best return over a longer horizon. Conversely, you can do quite well (or quite worse!) in a shorter time frame with individual stocks especially if you’ve done your research ahead of time.
Mr. Utopia @ Personal Finance Utopia recently posted…Build Your Confidence Instantly Using This Secret
I am going to have to start researching my investments. Right now I am dumping money into retirment but I have yet ot make any adjustments. I dont know where to start!
Ed recently posted…Where Else to Check EverydayLivingPNW Out
All of my investments are in mutual funds. I haven’t put in enough research to branch out and try index funds, so I’m not sure that I even want to. You seem to be a fan of them, though!
Daisy @ Prairie Eco Thrifter recently posted…So You’ve Maxed Out Your Emergency Fund – Now What?
Wow, I just wrote about this! I definitely agree with you that Index Funds are your best bet. I’m a strong proponent of them. Actively managed funds are more expensive and cannot guarantee higher returns.
Andrew@LivingRichCheaply recently posted…Why Invest in Index Funds?
All of my IRA money is in index funds right now. The cost is extremely low, and if you stick to broad ones like the S&P 500, it’s hard to go wrong. If you have no idea where to start, index funds make it much easier, and like your previous posts, getting started is the most important part.
Kim@Eyesonthedollar recently posted…Do I Have What It Takes To Be a Big Time Credit Card Churner?
While I don’t currently hold any investments, before taking on a mortgage I was a strong investor in index funds – only 20% of active mutual funds trying to beat the index in any given year were able to do so, and of those 20% not many of them were beating the index consistently (i.e. it was luck). By settling for ‘the average’ you’re actually beating 80% of professional investors!
Index funds definitely are a better choice than most mutual funds, especially now that bond funds are getting hammered with the winding down of the Fed’s QE program. Another way to do mutual funds is through ETF’s, which are pretty much the same thing, but more flexible. For example, any purchase or sale you make in a mutual fund is only executed at the close of tomorrow’s trading day. ETF trades are done “right now.”
William Cowie recently posted…I Don’t Have Time To Think About Investing
Mutual funds can be a real big waste for many investors which is why many financial advisers (although still selling a product) are recommending ETFs. Although their basic premise is easy to understand, confidence in them might not be.
I, like so many other comments, prefer to use a majority of individual stocks in my investing. I do have one account that is strictly commission-free ETFs, not because I favor them but as a way to mitigate risk and enjoy the commission-free trades.
I will never touch mutual funds.
Scott @ Youthfulinvestor.com recently posted…Does Owning International Stocks Really Help Diversify my Portfolio?
I was searching about mutual funds when I found this site. Great post here and I have learned a lot about mutual funds. Which do you think will you be taxed more mutual funds or index funds?
Jean recently posted…Setting Your Financial Goals
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