Index Fund Vs. Managed Fund

A mutual fund is a collection of stocks, bonds or both. Mutual funds could be index funds, which follow a market index, or they may be actively managed. Index funds sometimes are called passively managed funds.

Index Funds

An index fund seeks to closely track a market index, like the S&P 500, by owning the large number of stocks which are in the index. For instance, if the S&P 500 Index increased 5 %, a fund that tracks the S&P 500 could be expected to increase by the same amount. An index fund typically uses an electronic, or passive, approach that limits the volume of trades. When trades do occur, they are done to realign the fund with the index it tracks.

Index Fund Pros and Cons

An index fund's biggest advantage is it is highly diversified, which decreases risk. However, an index fund's capability to follow the market's performance also might be seen as a disadvantage, since such a fund inherently cannot outperform the market. An index fund does not sell under-performing securities, as an actively managed fund would, unless those securities fall off the index that the fund tracks.

Managed Funds

By having an actively managed fund, the managers take a dynamic role in evaluating and trading equities. They make day-to-day decisions about the fund's holdings, depending on the changes in the market.

Managed Fund Benefits and Drawbacks

The main advantage of a managed fund is that the managers look to maximize returns through trades. However, this increase in buying and selling of equities generally leads to greater risk and higher management fees, reducing an investor's profits.

How to Choose

Whether a managed fund or an index fund is better for you depends upon your goals and risk tolerance. Based on your age, you may choose to take greater risk to seek potentially larger returns with the a managed fund. Or you might choose to take potentially less risk with an index fund. Some investors choose to hedge their bets by owning both types of funds.