Index mutual funds match the investment returns of a certain group of stocks, carry lower annual expenses than other mutual funds, and are not actively managed, making them a “passive” investment. They are a collection of shares that are already diversified, making it easy for individual investors to invest in the stock market. John Bogle, the founder of Vanguard Group, is considered the “father” of index funds.
Index mutual funds are stock market investment tools that seek to match the investment returns of a certain group of stocks, called an index. Index mutual funds only own the stocks that make up the corresponding index, and carry lower annual expenses than other types of mutual funds. The fund owns shares in proportion to the weight of each share for the index. The different indices typically track a particular business segment of the stock market, such as financial institutions or companies based in Europe. Some indices track a large segment of the market, such as the largest 500 companies, or even the market as a whole.
A mutual fund is a collection of shares that the fund owns. An investment house establishes the mutual fund and sells shares of the fund to individual investors. Mutual funds make it easy for individual investors to invest in a diversified collection of stocks. Instead of trying to buy dozens of stocks to diversify an investment portfolio, an individual investor can invest in a mutual fund that is already diversified.
The fund management style differentiates index mutual funds from managed mutual funds. A managed mutual fund relies on a fund manager or stock selector to decide which shares to own and in what proportion to own them. The fund follows its original target sector, but the fund manager has a lot of leeway in selecting stocks and stock ratios. The fund manager might try to time market corrections, moving fund assets in and out of cash.
An index fund, meanwhile, is not actively managed. Instead, because the fund only owns stocks that match the index it’s trying to track, the index mutual fund manager doesn’t have to choose which stocks to own and in which configuration. An index mutual fund has a much lower cost of administration than a managed mutual fund because it doesn’t pay the fund manager to actively manage the fund, and the index fund passes those lower costs on to investors who own the fund. Managed mutual funds also buy and sell stocks much more frequently than index mutual funds, which means that actively managed funds incur more transaction costs than index mutual funds. For these reasons, an index mutual fund is sometimes called a “passive” investment.
In his book, Common Sense on Mutual Funds, John Bogle, the founder of the Vanguard Group, presents an in-depth look at the idea of index mutual funds. Investors consider Bogle the “father” of index funds, and Vanguard has offered index mutual funds to its investors since its founding in 1974. These days, many different investment companies offer at least a few index mutual funds. Funds that track the S&P 500 Index, which is an index that represents the 500 largest stocks in the US stock market, are common index mutual funds. Indices sometimes drop and add certain stocks, which means the index mutual fund must do the same, but such changes are rare.
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