The following is a post by MPFJ staff writer, Derek Sall. Derek is the owner of the blog, LifeAndMyFinances.com, where he teaches people how to get out of debt, save money, and become wealthy.
Have you ever heard of the term, “Index Fund?”
Don’t feel bad if you haven’t, but if you fail to learn about this term today, you may be leaving tens of thousands of dollars on the table.
I assume that many of you are familiar with the term, “Mutual Fund”. You might not know exactly what it means, but you know that it is a type of investment that you can purchase within your 401(k), and this is absolutely correct. An Index Fund is actually not all that different in principle, but I definitely prefer one over the other. Here’s why:
The Difference Between a Mutual Fund and an Index Fund
Mutual funds and index funds are both investments that can be purchased to increase your current savings and are often used to beef up your retirement account for the many years that you have before that last day on the job. While both of these funds essentially serve the same purpose, they are actually quite a lot different.
Mutual Fund –
A mutual fund is a managed account that often invests in a certain segment of the market.
For instance, there is most likely a fast food restaurant mutual fund that invests in McDonald’s, Burger King, Wendy’s, Arby’s, and many other fast food chains. The reason it is called a mutual fund is because it is mutually funded by many investors, allowing it to be affordable for each person. So, instead of having to buy one of each of these company shares for $50 a piece (which could easily total up to $1,000 with 20 company investments), you can purchase a small portion of each share (since all of the other investors do the same thing, which then totals enough money to buy whole shares) for a total of $50, instead of that $1,000.
Mutual funds are a great way to diversify your money when you don’t necessarily have a lot to invest. Also, many people believe that mutual funds are superior to individual investments because of the expertise of the fund manager and his/her team. Since they are constantly evaluating the market and its movements, investors believe that they can buy or sell stocks before the majority of stockholders even know there might be a problem or opportunity. If this is the case, then mutual funds are a great way to beat the market (meaning, earn a higher percent than the average stock market investor).
Index Funds –
An index fund is similar to a mutual fund because it also is made up of a large number of company stocks and easily invested in because of the many investors involved to fund the overall account. However, instead of the fund matching a particular segment of the market, the stocks are purchased in order to imitate a particular Index (like the Dow, Nasdaq, or S&P500). In other words, index funds are set up to earn you the same amount that the average investor would, but with a very hands-off approach.
The Research-
Many people swear by their mutual funds and believe that their investments are earning them more than the overall market (meaning, they are beating the market). However, many studies reveal that this is often not the case. While the gross earnings may be higher than the market, there are many fees that need to be considered as well. The largest of these fees are the management fees (totaling 1% or more of your total fund value each year), and then there are some other front-end and back-end fees that are charged when entering or exiting your money.
On the other hand, since index funds are incredibly simple and do not require a large management team, the fees are very small (often less than 0.1%) and do not hardly affect your investment at all.
By investing simply and keeping my investments in index funds last year, I earned almost 30% on my money. That is massive! And, because I am not employing a team of people to try to beat the market, I am able to keep the majority of these earnings as well.
If you are looking to invest for your retirement, I would advise that you look into a few index funds. You’ll earn more and be able to worry less. It is a simple, easy, and effective way to invest.
How about you all? How do you have your money invested? Do you use mutual funds, index funds, or something else all together?
Share your experiences by commenting below!
***Photo courtesy of http://www.flickr.com/photos/epsos/8450504146/sizes/l/
