Comparing Mutual Funds And Index Funds

Brant wants to know the difference between a mutual fund and an index fund. Dave is happy to explain.

QUESTION: Brant in Louisville wants to know the difference between a mutual fund and an index fund. Dave is happy to explain.

ANSWER: A mutual fund—if it's a growth stock mutual fund—is a group of stocks in growing companies, thus the name. An index fund closely matches whatever the index is that it's trying to match. The most popular and well-known index is the S&P 500—Standard & Poor’s. Standard & Poor’s is a rating company like the Dow Jones. They rate the top 500 largest companies on the New York Stock Exchange, which is the main large stock exchange. These are the 500 largest companies publicly traded that you can buy stock on in the nation. An index fund tries to mirror what would happen if you equally owned stock in all 500 of those companies.

The Dow Jones Industrial Average is only 30 stocks. SoIf you can imagine, statistically, the top 500 companies really do represent about exactly what the stock market's doing, more so than the Dow Jones Industrial Average really does. Five hundred is a better representation than 30. Those of us in the investment business consider that to be what the market is doing—the S&P 500. I own a bunch of index funds in the S&P 500. You're only going to do as good or as bad as the market does. You're not going to be worse than the market; you're not going to be better than the market. You are the market.