It is pretty easy to draw a conclusion that mutual funds are far better than investing in individual stocks when you do not have much knowledge about the stocks and how exactly financial analysis works, not only because of a lack of awareness but also because mutual funds provide you with a more diversified portfolio with customised risks.
But, when mutual funds itself provide varied range schemes with nuance differentiation. However, there are broadly two types of mutual fund schemes, actively and passively managed. On the basis of these two, other mutual fund schemes are crafted according to a demand made by the investors.
Mutual funds and index funds are the two investments that might confuse you the most. Let’s understand everything on the basis of following bases:
Investment strategy
Mutual funds are actively managed by a portfolio manager who selects individual securities based on their research and analysis in an attempt to outperform the market. On the other hand, index funds passively track the performance of a particular market index, such as the Nifty 50, by investing in all or a representative sample of the securities that make up the index.
Expense ratio
Because index funds follow a passive investment strategy, they typically have lower management fees and operating expenses than actively managed mutual funds, which require more research and analysis. This can result in lower costs for investors over the long term, as fees and expenses can eat into investment returns. Expense calculation is a significant part of investing as it impacts your overall return on investment.
Performance
While there is no guarantee of future performance, studies have shown that index funds tend to outperform actively managed mutual funds over the long term, in part due to their lower fees and expenses. This is because it is difficult for mutual fund managers to outperform the market and justify their higher fees consistently.
Diversification
Both mutual funds and index funds offer diversification benefits by investing in a portfolio of multiple securities. However, index funds typically offer broader diversification by investing in all or a representative sample of the securities in a particular market index. In contrast, mutual funds may focus on a narrower set of securities or sectors.
Suitability of the investors
When it comes to investing in mutual funds, you need to understand the basics of financial markets and do extensive research regarding the scheme in which you are planning to invest, research related to past records of the schemes, management of the AMC, and total assets under management (AUM).
On the other hand, index funds merely track the performance of an index and typically give similar returns as the underlying index. You do not require a comprehensive knowledge of the financial market as it is easy to understand and determine the time of exit from the market.
In the end, it is right to say that if you are still struggling with the confusion between index funds and mutual funds, you may, for now, invest in index funds while exploring the mutual fund schemes. However, it is better to have an appropriate mix of active and passive funds as they both have different potential growth rates in appreciating your capital.
Anushka Trivedi is a freelance financial content writer. She can be reached at anushkatrivedi.com
