Index vs. active mutual funds

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When selecting a mutual fund, one of the decisions is whether to invest in an index fund or actively managed fund. Active or index investing isn’t an either-or proposition. In fact, many mutual fund companies offer both types of funds. Likewise, many investors choose to use both types of funds in their portfolios to pursue different objectives.

About index funds

An index is a selection of investments intended to represent a particular market. Indexes like the Dow Jones Industrial Average* and the Standard & Poor’s 500** (S&P 500) make an appearance on the news every night. Other indexes represent markets that are less well known.  Index funds are based on indexes that track the performance of a particular market or investment style, such as growth or value.

About actively managed funds

An actively managed fund has a portfolio manager or a team of managers. Through the combination of research, market forecasting, experience and expertise, an actively managed strategy tries to beat a particular benchmark (usually a broad index).  In comparison, an index fund also has a portfolio manager, but the strategy attempts to match the performance of a particular index, not necessarily beat it.

How index and active funds differ

Index funds
Advantages
 
Simplicity, low costs, and exposure to a market without having to do research to select an active manager
Disadvantages
 
No opportunity to outperform the market index, or avoid components of the index that may perform poorly
Active funds
Advantages
 
Opportunity to outperform the market, depending on the manager you select and the fees charged
Disadvantages
 
May underperform the index if the manager makes poor selection decisions or if higher fees cut into performance

How to choose

Deciding which type of fund to buy doesn’t need to be an either-or.  Many investors use a mix of index funds and active funds in their portfolios to combine the cost advantage of indexing with the possibility of outperforming the market with active funds.  Consider working with an advisor who can help you select an appropiate mix of mutual funds for your portfolio.
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*The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.

**The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The S&P 500 is an unmanaged index which cannot be invested into directly. Past performance is no guarantee of future results.

TIAA products may be subject to market and other risk factors. See the applicable product literature for details.

Investing in mutual funds involves risk, including possible loss of principal.

This article is for general educational purposes only. It is not intended to be used as a substitute for specific individualized investment advice. Speak to an investment advisor regarding your situation.
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