Mutual funds have been a popular class of investment products for many decades. Index Funds have also been around for many years, but just a bit shorter length of time. Both can generally be classified as investment-grade products and are among the safest options for many types of individual investors as well as institutions. They both trade on the market in shares through brokers, and prices are based on the net asset value (NAV). Each is also issued a ticker that you can use to track price changes and trading activities. You may be wondering, if both asset classes have appeal for all types of investors, what makes the differentiation of index funds vs. mutual funds important? There are some key differences between the two investment vehicles.
All about mutual funds
Mutual funds are issued in various share classes. The reasons vary. Sometimes there are slight investment strategy differences between different products of the same fund. Other times there is a cost-to-entry difference that is tied to a minimum number of shares purchased. Both factors together may play a role in how a mutual fund gets named. A great way to grow your wealth without investing new capital is to select the option to reinvest your dividends. However, be mindful of capital gains which will be taxed even when you don’t redeem from your investment.
Mutual fund shares are defined as retail, institutional, and sometimes an advisor class. Vanguard, for example, has several funds with an advisor share class outstanding. Mutual funds are not limited by asset type. Fund managers develop products that cover a wide range of asset- and sub-asset classes. Within fixed income, you have core and extended strategies.
Equity truly broadens the field with US, non-US, emerging markets, and global sub-asset classes. Mutual funds are open-ended, which means outstanding shares can be both increased and decreased daily based on the total number of buys and sells. Some mutual funds are closed-ended, but they function more like index funds which are entirely equity-based. Trades are closed based on the end of day price.
What are the advantages of index funds?
Index funds are passively managed, which gives them lower feeds. Once the basket of stocks on an exchange is selected after the fund IPO, they remain. Mutual funds are actively managed, which gives them higher fees—but with that comes higher returns. Index ETFs have the advantage here with (1) lower cost of entry, (2) lower capital gains, and (3) lower taxes. If you had to make a quick comparison of index fund vs. mutual fund, index funds are likely to generate returns at or only slightly above market price. If you are interested in a long-term, low-cost, low-income model, then between index funds vs. mutual funds, index funds are the best option.
Index funds are traded throughout the day and track a single market index. When a broker places your trade, it’s called the intraday price. Reinvesting in index funds is not only a newer option, but it is riskier. Since prices fluctuate throughout the day, the price you request for a dividend reinvestment may not be the same price you get for those shares at market closing. You will likely end up with some fractional amount of cash leftover or fewer dividends reinvested when a price increases.
With so many funds to consider, how do you know which is the best choice?
There are literally thousands of traditional funds to consider; therefore, selecting an investment advisor is a wise option. It helps a lot to have a financial planner to review your goals with to help you decide whether you need index funds, mutual funds, or a mix of both. SD Mayer has helped people get answers to questions like this for decades. SDM Advisors believes in taking a holistic approach to wealth management to achieve the best strategy overall for its clients, and advisors will work closely with you to determine the best investing strategy for you and your particular financial situation.
Advisors at SD Mayer have decades of experience managing investments, including index and mutual funds. Our wealth managers will sit down with you and carefully examine your situation, collaborating closely with you to craft the best possible strategy to help you achieve your financial goals. Contact us today to get started.