INDEX FUNDS are the easiest way to start investing and create wealth. But paid media and ads cloud our judgment and make us choose the wrong product. These wrong choices cost us thousands of dollars in fees.
Many of us struggle to figure out how to buy either Index or Mutual funds and which one is best for them.
In this video, we will see the difference between Index and Mutual funds and I will make it easier for you to make better choices. I am also going to tell you something about banks which no one talks about.
It takes a lot of research, reading and investing to figure out what’s the best option.
Once you make a decision and know it’s correct, you just need to stick with it as long as possible. Investing consistently over a long time is the key to building huge wealth but a lot of people sell out their investment or don’t continue thinking it’s growing very slowly.
INDEX\BENCHMARK
First we must understand What is benchmark or Index is to understand the difference between Index and Mutual Funds.
For Example: S&P 500 INDEX takes top 500 stocks in the STOCK MARKET and keeps track of performance of that. It’s an index, not a fund. But there are many INDEX funds like Vanguard S&P 500 which are built similar to S&P to give similar performance.
KEY DIFFERENCE\DEFINITION
INDEX FUNDS
Follows the benchmark stock exchange or index like S&P 500.
It closely follows one of the INDEXES like S&P 500 or Dow Jones and it’s very close to 100% stocks.
MUTUAL FUNDS
Professionally Managed, Combination of Hand picked Stocks, Bonds and Cash.
Mutual Funds Manager or bank which owns the mutual funds decides which stocks they want in the mutual funds, they will pick whatever stocks they want from certain sectors to add to the fund to get the best returns or to make sure it’s safe to invest. They also add some Bonds or also keep some cash to keep funds safe as these things are backed up by the government.
It’s very rare that Mutual funds are 100% stocks, because they normally try to make it safe for investors and they always add Bonds or keep some cash.
The core difference between them is how decisions are made about a fund’s holdings, the goals of the fund and the cost of investing in each fund.
MANAGEMENT
INDEX FUNDS
PASSIVE – There is no one to actively manage Index funds, No matter what happens like the market may go up or go down, it will remain as it is.
MUTUAL FUNDS
ACTIVE – Mutual Funds are actively managed by a team and they always keep on making changes as the market goes up or down either to maximize returns or to reduce risk. Both non-managing and managing has its own pros and cons, sometimes it’s not good to make a lot of changes as no one knows how some stocks are going to behave in future. Making changes to funds can also generate capital gain taxes as they sell some and buy some.
FEES
INDEX FUNDS
Since no one is managing Index funds, so there are not a lot of management fees, they still charge some small fee like 0.01 – 0.7% which is still much much lower than Mutual Funds.
MUTUAL FUNDS
Mutual funds have a big team working for it and they charge big fees like 2-3.5% and this reduces your returns big time, imagine, Mutual funds with fee 2.5% have to do almost 2.5% better than index fund to do better. That’s why Mutual Funds rarely do better than Index funds in the long run.
Even 1% in fees can cost you a lot of money, let alone paying over 3%, Just because of the fee, I always prefer to invest in INDEX FUNDS. That’s why WARREN BUFFET suggests investing in INDEX FUNDS.
All the MUTUAL FUNDS are trying to actually beat INDEX FUND, so why not just buy INDEX FUND which is much likely to give you better returns.
RISK AND RETRUNS
INDEX FUNDS
INDEX FUNDS are higher risk because it’s almost 100% stocks and when the market goes down, INDEX FUNDS get the big hit. So, it may not be for you if you are very sensitive to short time losses. But remember when the Market goes back up, INDEX FUNDS goes up much more than MUTUAL FUNDS.
MUTUAL FUNDS
These are normally combinations of Stocks, Bonds, Cash. So, even if Stocks fall, you still have a bit of protection with Bonds and Cash.. But you have to live with lower returns.
In the short run, INDEX FUNDS can be risky, so if you are investing less than 5 years, then choose Mutual.. But if you are investing over 10 years then you should always go with INDEX FUNDS.
CONVIENCE TO INVEST
No one normally talks about this and I learnt this from my personal experience that banks make it very difficult to buy INDEX FUNDS. Because banks are in the business of making fees and why they want you to invest in INDEX FUNDS when they are making a lot of fees with MUTUAL FUNDS.
INDEX FUNDS
You have to check with many banks and see which one lets you buy INDEX FUNDS easily, I am using RBC bank right now in Canada. Normally banks don’t want to set up automatic investment like they do with MUTUAL FUNDS, they normally tells you to go to their investment site and buy INDEX funds yourself every time which I don’t prefer because I want to set up a system which buys INDEX FUNDS every month without me doing anything.
MUTUAL FUNDS
While MUTUAL FUNDS are easily available, just go to any bank and ask them to invest in MUTUAL FUNDS, they have so many choices that you may get confused to pick one. Now even they have Mutual Funds of Mutual funds. Like one fund which has the Funds in it. That is just crazy. They are just finding ways to charge you fees.
BOTTOM LINE
INVEST IN INDEX FUNDS if you really want good returns over time.
