Actively Managed vs. Index Mutual Funds: Which Is Right For Your Investing Needs?

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When most people get started with investing, it’s rare that they jump right to trading individual stocks. After all, dealing in this type of equity successful – meaning, you don’t lose your hard-earned cash - requires a level of expertise that most new investors don’t have. A much more novice-friendly investment is the mutual fund, which is what many gravitate towards. This is with good reason: mutual funds provide an easy way to achieve built-in diversification and they’re relatively simple to buy into and keep track of. For most of us, these qualities make the mutual fund a top-notch choice for our investment needs.

However, if you’ve done any research about mutual funds, you’ve probably noticed that they come in two flavors, actively managed and index. If you’re not familiar with the definitions of these terms, let’s clear that up right away:

  • Actively managed funds employ a financial professional to buy and sell the stocks and bonds contained within the fund; these transactions might not occur frequently, but someone behind the scenes is wheeling and dealing to try to get the fund to perform as well as possible.
  • Index funds are passively managed, meaning that there’s no financial professional at the helm doing the buying and selling. These funds have been designed in such a way that they track the performance of a particular financial index, such as the S&P 500.

Prior to 1976, the only type of mutual fund out there was an actively managed fund. It wasn’t until John Bogle, founder of the Vanguard Group, decided to experiment with creating a passively managed fund that the index fund came into existence, and since that time they’ve been gaining popularity.

But why? After all, having a professional investment manager keeping track of your mutual fund’s performance and buying and selling accordingly sounds like a good thing, right?

Well, not always. For one thing, it costs money to employ that professional manager, and those costs are passed on to investors in the form of fees. Over time, those fees can really add up to cut into your investment returns. Also, he stock and bond markets are tricky and unpredictable, even for well-trained professionals. Data has shown that most mutual fund managers aren’t able to beat the equity indexes when it comes to investment gains, meaning that, in both cases, you’d be better off choosing an index fund anyway.

If you do choose to go with an actively managed fund, be sure to shop around to find the one with the lowest fees and the best historical track record – there are a lot more funds out there that meet these requirements than ever before. In most cases, though, the average investor will enjoy better returns at a lower cost by using index mutual funds as their primary investment vehicle. After all, the name of the game is making money, not spending it, so think about getting started with low-cost index investing today.

About Lindsay Meredith

Lindsay is a high school teacher and personal finance blogger. She lives, works, and plays in the Washington, D.C. area.

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