Index Mutual Funds Are Low Cost And Low Fees Mutual Funds

Index mutual funds operate principally by tracking the performance of a reputed bond or stock index. Because of this they are known as collective investment schemes that focus on replicating movements of financial markets. Another definition describes an index fund as a mutual fund or ETF (Exchange Traded Fund) which has defined and fixed rules of ownership that remain constant irrespective of prevailing market conditions. It also assumes that the fund is not bound to follow some reputed index.

However, seasoned index fund managers focus on two major areas; 1) tracking the chosen index very closely and 2) minimizing expenditure and fund costs. Some of the indices that such funds tend to follow are the Wilshire 5000, the S&P 500, the FTSE All-Share Index and the FTSE 100

The first index mutual fund for individual investors was started by John Bogle on the December the 31st, 1975 under the name First Index Investment Trust. This was later named as the Vanguard 500 Index Fund. This fund tracks the Standard and Poor's 500 Index. Starting with assets worth just $11 millions, the fund's assets surpassed the $100 BILLION mark in 1999. It would be interesting to note that its performance over the last three to five years has been above ninety percent of domestic mutual funds, international equity funds and bond funds.

The fundamental idea of John Bogle behind index mutual funds was to create a mutual fund of very low cost without attempting to have a unique portfolio in order to beat the S&P 500 index. Instead it was supposed to mirror the index by purchasing all the indexed stocks in proportion to the weight ages attributed to each within the index and get results better than actively managed funds. He predicted that the difference in end results should be around 1.5 %. Time has proven the astuteness of his surmises/theory as the difference between the two types has been a phenomenal 3.4% during the 1990s, much above his own calculations.

To understand the difference between index mutual funds and other funds, it is also necessary to understand how expense ratios, market sector, turnover and cash reserves affect the investment in the fund. These are major factors affecting the final outcome.

Expense ratio: Other fund types charge around 1.5 % as expenses from their investors. In contrast, index mutual funds have a very low expense ratio. The Vanguard S&P 500 has an expense ratio of merely 0.19%.

Turnover: Other funds buy and sell holdings at a very past pace. This imposes approx. 0.7 % in transaction costs and results in only 15 % of the same stocks remaining with them at the end of the year. The portfolio profile also becomes considerably changed. This is radically different from index mutual funds operations.

Cash reserves: With a view to time the markets, other fund managers hold back nearly 8% of their portfolios as cash reserves which proves very costly increasing overall costs of maintaining the fund.

The details given above highlight ways in which additional costs are imposed on actively managed funds leading to lesser profits and greater risks. This is why it is said that the most simple and intelligent way of investing in a mutual fund is to buy shares of an Index Mutual Fund.