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Index funds are passively managed funds designed to mimic the performance of an index, such as the S&P 500®. Mutual funds are typically actively managed by a portfolio manager who strategically buys and sells securities in an attempt to outperform a benchmark index.
Technically, an index fund may be a type of mutual fund or a type of exchange-traded fund (ETF). However, there are key differences between index funds and actively managed mutual funds that investors need to understand to effectively implement them into an investment strategy. Those differences may include investing strategy, risk level, associated fees and taxes, and liquidity, among others.
Key Points
• Index funds aim to mirror the performance of a specific market index, using a passive investment strategy.
• Mutual funds may be actively managed by fund managers who select securities to attempt to outperform the market.
• The costs associated with mutual funds are generally higher due to active management fees.
• Index funds typically have lower expense ratios, making them a cost-effective option for investors.
• The choice between index and mutual funds depends on individual investment goals and preferences for active versus passive management.
What’s the Difference Between Index Funds and Mutual Funds?
Index funds and mutual funds are similar in many ways, but they do differ in some others, such as how they work, associated costs, and investment style.
How They Work
Index funds can be a type of mutual fund, interestingly enough, or they may be structured as an exchange-traded fund, or ETF. Index funds are distinguished by their investing approach: Index funds invest in an index and only change the securities they hold when the index changes or to realign their holdings to better match the index they invest in.
Rather than rely on a portfolio manager’s instincts and experience, an index fund tracks a particular index. There are benchmark indexes across all of the different asset classes, including stocks, bonds, currencies, and commodities. As an example, the S&P 500® Index tracks the stocks of 500 of the leading companies in the United States.
An index fund aims to mirror the performance of a given benchmark index by investing in the same companies with similar weights. With these funds, it’s not about beating the market — it’s about tracking it. As such, index funds typically follow a passive investment strategy known as a buy-and-hold strategy.
A mutual fund is an investment that holds a collection, or portfolio, of securities, such as stocks and bonds. The “mutual” part of the name has to do with the structure of the fund, in that all of its investors mutually combine their funds in this one shared portfolio.
Mutual funds are also called ’40 Act funds, as they were created in 1940 by an act of Congress that was designed to correct some of the investment abuses that led to the Stock Market Crash of 1929. It created a regulatory framework for offering and maintaining mutual funds, including requirements for filings, service charges, financial disclosures, and the fiduciary duties of investment companies.
To get people to invest, the portfolio managers of a given mutual fund offer a unique investment perspective or strategy. That could mean investing in tech stocks, or only investing in the fund manager’s five best ideas, or investing in a few thousand stocks at once, or only in gold-mining stocks, and so on.
Fees and Taxes
There may be different associated costs with index funds and mutual funds as well.
Mutual-fund managers generally charge investors a management fee, which comes from the assets of the fund. Those fees vary widely, but an active manager will generally charge more, as they have to pay the salaries of analysts, researchers, and the stock pickers themselves. Passive managers of index funds, on the other hand, simply have to pay to license the use of an index.
According to recent research from the Investment Company Institute (ICI), the average expense ratio (which includes the management fee) for equity mutual funds in 2025 was 0.40%, compared to 0.14% for index equity ETFs and 0.05% for index equity mutual funds. Mutual funds are almost always more expensive than ETFs. In the case of passive index funds, however, ICI notes that mutual funds may offer lower expense ratios due to economies of scale and holding a higher share of lower-cost assets.
Investing Style
The two also differ on a basic level in that index funds are a passive investing vehicle, and mutual funds are typically actively managed. That means that investors who want to take a hands-off approach may find index funds a more suitable choice, whereas investors who want a guiding hand in their portfolio may be more attracted to mutual funds.
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Mutual Funds vs. Index Funds: Key Differences |
|
|---|---|
| Mutual Funds | Index Funds |
| Overseen by a fund manager | Track a market index |
| May have higher associated costs | Typically has lower associated costs |
| Active investing | Passive investing |
Index vs Mutual Fund: Which Is Best for You?
There’s no telling whether an index or mutual fund is better for you — it’ll depend on specific factors relevant to your situation and goals.
When deciding how to invest, everyone has their own unique approach. If an investor believes in the expertise and human touch of a fund manager or team of professionals, then an actively managed fund, such as a mutual fund, may be the right fit. While no one beats the market every year, some funds can potentially outperform the broader market for long stretches.
But for those individuals who want to invest in the markets and not think about it, then the broad exposure — and lower fees — offered by index funds may make more sense. Investing in index funds tends to work best when you hold your money in the funds for a longer period of time, or use a dollar-cost-average strategy, where you invest consistently over time to take advantage of both high and low points.
The Takeaway
Index funds and mutual funds are similar investment vehicles, but there are some key differences, which include how they’re managed, the costs associated with them, and how they function at a granular level.
The choice between index funds and other mutual funds is one with decades of debate behind it. For individuals who prefer the expertise of a hands-on professional or team buying and selling assets within the fund, a mutual fund may be preferred. For investors who’d rather their fund passively track an index without worrying about beating the market, an index fund might be the way to go.
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FAQ
Do index funds outperform mutual funds?
Mutual funds may be outperformed by index funds. Actively managed funds are designed to outperform a benchmark, while index funds are designed to match it. However, the performance of mutual funds can vary depending on the type of fund and timeframe considered.
Some studies of historical data suggest many actively managed funds have underperformed their benchmark indexes over long periods, after fees are considered. However, some active managers do outperform for stretches of time, and past performance is never a guarantee of future results.
Do people prefer index funds over mutual funds, or mutual funds over index funds?
The types of funds that investors prefer to invest in depends completely on their own financial situation and investment goals. But some investors may prefer index funds over mutual funds due to their hands-off, passive approach and lower associated costs.
Are mutual funds riskier than index funds?
Mutual funds may be riskier than index funds, but it depends on the specific funds being compared. Mutual funds do tend to be more expensive than index funds, and tend to underperform the market at large, too.
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Investment Risk: Diversification can help reduce some investment risk, but cannot guarantee profit nor fully protect in a down market.
S&P 500 Index: The S&P 500 Index is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S. It is not an investment product, but a measure of U.S. equity performance. Historical performance of the S&P 500 Index does not guarantee similar results in the future. The historical return of the S&P 500 Index shown does not include the reinvestment of dividends or account for investment fees, expenses, or taxes, which would reduce actual returns.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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