Mutual Funds Vs. Index Funds: Top 5 Major Differences | Motilal Oswal

Major Differences on Mutual funds and Index funds

If you are still unsure about whether to invest in index funds or mutual funds, you need to keep in mind that your decision should be based on your financial situation and objectives. They are comparatively more diversified, risk-mitigating. However, when it comes to mutual funds, there will be a plethora of options for you to look at. 

1. Investment And Management Approach

Fund allocation and management are the key differences between mutual fund and index funds. Actively managed mutual funds require the fund managers deciding to choose the asset mix and investment proportion. As a result, the success of the funds is strongly reliant on the fund manager's expertise, biases, and skill sets.

Index funds, on the contrary, are managed in a passive manner. As a result, these funds use the underlying benchmark in the form of a framework for investment and therefore tend to mimic its characteristics. As a result, index funds provide a rather hands-off approach to investing.

2. The Expense Ratio

From the standpoint of an investor, the most significant distinction between mutual funds and index funds is their operational costs. The expense ratio is the annual costs of administering these funds' operations. This is calculated as a proportion of a scheme's AUM.

As previously stated, actively managed mutual funds require fund managers to conduct substantial industry research on a regular basis. Following that, they select securities from which to mobilize available assets. As index funds are managed passively, a fund manager's involvement is minimal. Mutual funds have low expense ratios. These fees, however, differ amongst fund firms.

3. Performance

The performances of mutual funds and index funds will be compared under various market scenarios. Mutual funds that are managed actively, particularly equity-oriented funds, seek to outperform market benchmarks. The goal that fund managers achieve is through combining and contrasting holdings. During market downturns in many industries, these funds outperform the market and provide higher returns. Index funds have a track record of outperforming funds that are actively managed in over 80% of cases. 

4. Simplicity

When choosing a mutual fund, you as an investor must conduct considerable study before making a decision. Before investing, take into account prior returns, fund manager performance, total AUM, and other factors. Index funds which have the same or similar index, in most cases, have very similar returns. It is straightforward, because the decision is largely based on the tracking error and expense ratio.

5. Risks

There is no such thing as a risk-free mutual funds investment. Since the index funds are a sort of mutual funds, market volatility has a significant impact. The type of risk is a prominent distinction between Index Funds and mutual funds.

The risk in mutual funds that are actively managed is mostly determined by the market capitalization of the assets. For example, a large-cap fund is known for providing consistent returns with little volatility. Small and medium-cap funds are used in an investment strategy that is more aggressive. These funds are invested in units with a strong potential for growth, resulting in larger returns. However, they are far more volatile in comparison to large-cap stocks and can result in significant losses in a downturn.

Bottomline

While mutual funds happen to have a reputation of being better than index funds, fund managers that actively work can also be highly efficient. Index funds, on the other hand, are a good option for investors who are just getting started with mutual funds.

Related Aritcles:

How to Analyse Mutual Funds for Big Returns | Things to Know Before Investing in Mutual Funds | Mutual Fund - Need of Financial Plan | How to Open a Demat Account Without a Broker | Factors to Keep in Mind While Opening a Demat account 

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