Index Fund Vs. Managed Fund
A mutual fund is a collection of stocks, bonds or both. Mutual funds can be index funds, which follow a market index, or they can be actively managed. Index funds sometimes are called passively managed funds.
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Index Funds
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An index fund seeks to closely track a market index, such as the S&P 500, by owning the large variety of stocks that are in the index. For example, if the S&P 500 Index went up 5 percent, a fund that tracks the S&P 500 would be expected to increase by the same amount. An index fund typically uses an electronic, or passive, approach that limits the number of trades. When trades do occur, they are done to realign the fund with the index it tracks.
Index Fund Pros and Cons
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An index fund's biggest advantage is that it is highly diversified, which decreases risk. However, an index fund's ability to follow the market's performance also could be seen as a disadvantage, since such a fund inherently cannot outperform the market. An index fund does not sell under-performing securities, like an actively managed fund would, unless those securities drop off the index that the fund tracks.
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Managed Funds
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With an actively managed fund, the managers take an active role in evaluating and trading equities. They make day-to-day decisions about the fund's holdings, based on changes in the market.
Managed Fund Pros and Cons
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The main advantage of a managed fund is that the managers seek to maximize returns by making trades. However, this increase in buying and selling of equities generally leads to greater risk and higher management fees, reducing an investor's profits.
How to Choose
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Whether a managed fund or an index fund is better for you depends on your goals and risk tolerance. Depending on your age, you may chose to take greater risk to seek potentially larger returns with a managed fund. Or you might prefer to take potentially less risk with an index fund. Some investors choose to hedge their bets by owning both types of funds.
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