Updated: Mar 10
I have to admit that because of my involvement in finances, I take a lot of things for granted. I got a question yesterday about index funds. Do you know the difference between an index fund and a mutual fund? To learn about mutual funds you can read about them here. So what is an index fund? Perhaps you heard of the S&P 500 index fund. Do you know what makes it different?
An index fund is a mutual fund. It is still made up of companies like a regular stock mutual fund. You still get dividends and capital gains, should they occur, like a regular stock mutual fund. The big difference is that an index mutual fund is mimicking the index they follow. In the case of the S&P 500 an S&P 500 index fund will mimic the companies in that index. The S&P 500 is made up of the 500 largest companies in the United States. Companies like Apple, Google, etc. If you think of a very large company, it will probably be in the index. This index is the standard which people compare mutual funds against.
The S&P sets the bench mark, and regular stock mutual funds try to beat that. I have funds you can read about here that, on average, beat the historical returns of the S&P 500. That is why I don’t tend to recommend index funds for retirement accounts. You can get better returns in regular stock mutual funds. However, some regular stock mutual funds buy and sell companies within the fund. That buying and selling will generate more taxable income. If that is not protected in a tax differed account you will find yourself paying more taxes when you file your tax returns.
However, in a non-retirement account I like index funds because they generate little tax consequence. Since an S&P 500 index fund is mimicking the index, it is not buying or trading companies throughout the year. The largest 500 companies usually don’t fall out of the top 500. The same 500 companies tend to remain the same.
Also since index funds don’t require lots of trading within the fund, they have very low fees—much lower than a regular stock mutual fund. If you aren’t careful, you may pay high fees in a regular stock mutual fund. Because index funds fees are very low, I recommend using them in non-retirement accounts.
I hope that helps you understand the difference between an index fund and a regular stock mutual fund. Both are mutual funds—one just mimics an index, the other chooses companies on their own, not mimicking an index.
If you have questions don’t hesitate to ask here. Take charge of your money!
Your biggest cheerleader on social media,
P.S. Day 297 please pray for the 7.2 million goal for 2020