Index Versus Managed Mutual Funds

Index funds are passive funds. They are passive in that they simply follow a particular stock index. These indexes could be the S&P 500, the NASDAQ, or any other of a number of market indexes. Index funds do not have managers because there is little or no buying or selling. The fund simply holds the stocks of the index and leaves it alone.

A managed fund, as the name implies, is more active. Like the index fund, the managed fund is a basket of stocks. Unlike the index fund, a manager of the fund actively seeks to maximize profits by buying and selling stocks in the fund. This active management creates two primary differences between the two kinds of funds.

Because the fund has a manager, the manager must be paid. Therefore, the fees for managed funds tend to be higher. Because stocks are being bought and sold, there is a level of speculation not found in index funds. Managed funds, while diverse, tend to have more volatility with higher risk. It is possible to make more money in a managed fund and it is possible to lose more money.

In short, an index fund is a more conservative investment. An index fund is not likely to lose money but it is not likely to make a lot of money either. If the index consists of a segment of the stock market, like the Wilshire 500 or the FTSE 100, it is likely to lose money when the economy is slow and the overall market is down. This would also be true of managed funds.

If you decide to go with a managed fund, your research should not be so much in the stocks contained in the fund as much as in the manager of the funds. You need to look at his or her track record and the track record of the fund you are looking at. Many funds specialize in specific industries, so you want to choose an industry that is doing well or is expected to do well in the future.

For example, in a managed fund you would not want to go into housing or construction stocks right now. If you look around at what is happening in the economy, you see that housing is still on the decrease. You also see that banks are failing or getting bailed out. A financial fund would be a high risk right now.

Instead, you look at what is doing well and should do well in the foreseeable future. That would be commodities. Food and energy are likely to be good investments in the near term. If the dollar continues to fall, precious metals and oil will continue to rise.

The difficulty today in choosing an investment vehicle is that inflation is much higher than the government is telling us. In order to break even with your investment, you will need to earn a minimum of 10%. Most index funds cannot bring in that kind of return with any consistency. Look for a return of 15% or better.

Still, it would be a good idea to put some of your investment in a good index fund and then use your high-risk money in a good managed fund likely to grow in the current economic climate. On the other hand, it’s possible to buy a fund that follows an industry like commodities. The fund may be managed, but it will be far less than many managed funds because of the narrow focus.

Educate yourself on market trends and then follow the trend, whether you do it with index or managed funds.