Finance > Investing in the Stock Market
Index Funds vs Actively Managed Funds
Whilst you might assume a managed fund has a higher return, some index funds are extremely hard to beat. This article gives initial insights into both types of funds and some factors to consider when choosing between the two.
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Index Funds
- Aim
An index fund aims to track the performance of parts of the market as close as possible.
- How?
Index funds tend to buy a representative sample of the shares within the index it wishes to track. When changes occur within the index, the fund will emulate these changes by updating its own holdings accordingly.
- Main Benefit
Index funds are diverse, cheap and simple.
- Risk
All risk is linked to the section of the market the index aims to track.
Actively Managed Funds
- Aim
The fund manager aims to choose investments that can outperform the market.
- How?
Funds pool all of the money that investors have chosen to invest in that particular fund, and they use it to buy a range of shares and bonds etc. on behalf of the investors.
- Main Benefit
Fund managers use their knowledge and experience to try to beat the market.
- Risk
While risk is linked to the performance of the market sector the fund focuses on, it is also linked to the fund manager’s ability to pick winning investments.
Additional Considerations
In addition to the points above, there are a few other key points to consider when choosing between these two types of fund.
- Fees
Actively managed funds tend to come with higher fees than index funds due to them requiring a lot more care and attention – they are actively managed, after all. As a result, even if actively managed funds can match the performance of the index, the returns may still be less.
- Trading Frequency
Due to managed funds actively trading for the best result, they complete a higher volume of trades than index funds. A higher volume of trades will come with additional charges, which eat into your returns.
The Bottom Line
Whilst both types of funds come with their benefits and drawbacks, the investment decision ultimately lies with the individual, their appetite for risk and financial objectives. Although index funds have historically proven hard to beat over the long term, it has been done. Good fund managers do exist; perhaps the most difficult part is finding them prior to their period of outperforming the market.
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