Index and actively managed mutual funds can both provide diversification, ‘professional’ management and convenience. There are differences between the two types of funds and they each have their own traits, performance and risks.
Here are three things to know about the differences between these two fund types:
- Index funds aim to track a particular investment index. It holds the same stocks in the same percentages as the underlying index. There are no subjective management decisions and performance should be very consistent with the underlying index it tracks (less the expense ratio.
- Active funds aim to outperform a particular investment index. The fund has parameters that let it hold more or less individual stocks in the index as well as other investments that may not be in the underlying index. There are subjective management decisions and performance can deviate from the underlying index it is based on.
- Index funds typically provide broad exposure to market segments by including only securities within a specific index.
- Active funds own securities researched and handpicked by portfolio managers.
- Index funds tend to have lower fees
- Active funds have higher expenses related to the effort involved in managing them.
Both types of mutual funds can play an important but different role in a portfolio, depending on your goals and risk tolerance.
As an example:
ACTIVE FUND
T. Rowe Price Blue Chip Growth (TRBCX) is a US large cap growth fund. It is actively managed with an expense ratio of 0.70%.
- Expense ratio higher than an index fund
Its 2024 YTD performance is 14.78% (5/9/2024). Its 10-yr track record of annual performance is 14.45%.
- Performance is above the investment index year to date
It can invest in large and medium-sized blue chip growth companies
- Deviation from the underlying index
It is made up of 82 individual stocks and is based on holdings in the S&P 500 Index, Russell 1000 Growth Index and the Lipper Large-Cap Growth Funds Index.
INDEX FUND
Vanguard Growth Index Fund (VIGAX) is a US large cap growth fund. It is an index fund with an expense ratio of 0.05%.
- Expense ratio is very low
Its 2024 YTD performance is 10.41% (5/9/2024). Its 10-yr track record of annual performance is 15.04%.
- Performance is lower year to date than the active fund, but the 10 yr. return is higher than the active fund
It invests only in stocks found in the CRSP US Large Cap Growth Index
- No deviation from the underlying index
It is made up of 199 individual stocks and has very little deviation from its benchmark index.
As you can see there are pros and cons to each type of fund. Investors should do their research to find out which type of fund – or mix of funds – could work for their portfolio.