Index Funds vs Mutual Funds

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Difference Between Index Funds and Mutual Funds

Both index funds and mutual funds are used to diversify the portfolio. In contrast, index funds are closed-ended funds that generally track the index without deviating their holding. In contrast, mutual funds are open-ended funds that are managed actively, which deviates from their benchmark by investing in a variety of stocks.

Both funds are a source of investment and are saved in subscribing to the fund’s units. Many funds possessing different characteristics and strategies are in the market, and investors can select from the pools of the fund to invest from.

There are different types of funds in the market, like equity mutual fund, mutual debt fund, hybrid mutual fund, index fund, exchange-traded fund, etc.

Difference Between Index Funds and Mutual Funds

Index Funds vs Mutual Funds Infographics

Let’s see the top difference between index funds vs. mutual funds.

Key Differences

The critical difference between them are as follows –

The significant difference is that mutual funds investment objective is to exceed the benchmark return of the market or whichever funds of fund the mutual fund is investing in. On the other hand, the investment objective of an index fund is to maintain or match the return of the benchmark index, for example, to check the return of S&P index 500, etc.
Index funds, which are the fund’s investment mix, are generally automated as it is an investment in the exact holding type as the index, which is set as a benchmark index for the fund. On the other hand, the investment of mutual funds is mostly active. In contrast, mutual funds track the company or the share of the various stocks in the industry and withdraw and invest their holding in beating the return of the market.
The index funds track the performance of the index, which is set as a benchmark, whereas mutual funds track the performance of the various stocks they have held and follow the performance of their holdings.
Mutual funds are mostly open-ended funds, whereas index funds are close-ended and generally have a lock-in period.
Index funds do not have a large management team as the investment in this fund is passive investing. As a result, the fees lost in index funds are not such a large amount of the return compared to mutual funds, which are actively managed and have a large investment team.

Index vs Mutual Funds Comparative Table

Index Funds	Mutual Funds
It doesn’t charge high fees as compared to mutual funds.	Due to active investing, it charges high management fees, generally 2% of the asset under management.
History has indicated that the return of passive investment, i.e., they outperform the returns of mutual funds.	These are easy to beat and outperformed compared to index funds in practical terms.
It generally tracks a particular index and does not deviate its holding from that index.	It deviates from the benchmark and can invest in various stocks since they make active investments and track the stocks.
Closed-Ended	Open-Ended
Short to the medium time investment horizon	Generally, the long investment horizon is useful when an investor opts to invest in these funds.
Investment is in an index that purchases all the stock in the same proportion as the index.	Investment is in stocks. There is no fixed proportion of stock investment, and they invest in stocks according to the company's performance or the intrinsic value of the stock.
It incurs less expense. It does not incur a considerable expense in the selling and buying stock; hence the expense ratio is less than the mutual funds.	It incurs a high cost in the purchase and selling of stocks, and hence the expense ratio of the fund is a considerable amount, which also affects the fund's return.

Final Thoughts

Whether to invest in the index or mutual funds is a question of the investor's investment objective, and it also depends on the time horizon and the investor’s risk appetite. However, history has suggested that the index fund’s return has outperformed the recovery from the mutual fund. It is mainly because of the expense and the management fees, which are significant amounts in mutual funds.

In India, the exposure to index funds is less when compared to mutual funds and also other developed markets. But in developed economies like the United States, the index fund has recently become a significant source of investment and return. Many investors have been lured into this scheme by active fund houses. Investment options should be weighted in light of the budget. Also, investor awareness about the new products in the market is critical for investors actively looking for financial assets to invest their hard-earned money.