1. An index fund can be a mutual fund

Even though it might sound confusing, Clayton Wood, a financial planner, says a good first step in understanding that an index fund is a mutual fund, but a mutual fund is not always an index fund.

“A mutual fund is the pooling of money from multiple sources to invest in a bucket of investments usually managed by an asset manager,”says Wood. “A mutual fund’s investments are guided by its Investment Objectives, which are found in the prospectus of the fund.”

So how is an index fund different from a mutual fund? Wood says that an index fund is the pooling of money that invests in a portfolio that tracks an index, like the S&P 500.

“The investment objective of the index fund is to mirror the investments and allocations of the index that is chosen,” said Wood. 

2. Index Funds have a lower expenses

When it comes to fees, Alvin Carlos, a financial planner, says that index funds are low-cost mutual funds.

“It’s the Costco of investing,” said Carlos. “Index fund fees can be 10x lower than an averagely-priced mutual fund. Also, Index funds can give you better returns compared to a mutual fund.”

“Studies show that you can make more money by investing in low-fee index funds compared to higher-fee mutual funds,” he added. “More than 82% of mutual funds underperformed an S&P 500 index fund over the last 10 years.”

3. They have different themes

Depending on the risk you’d like to take, and how much you’d like to diversify your investment portfolio, Jay Kirkwood, a financial planner, says that it’s good to know the different themes of index funds versus mutual funds.

“An index fund will track a specific index of stocks. You may be familiar with some such as the Nasdaq, S&P 500 and the Dow Jones,” said Kirkwood. “Other mutual funds may focus on a specific theme such as emerging markets and growth stocks.”

4. Mutual funds are managed by professionals

If you’re looking to have a professional in charge of your investments, Amy Richardson, a financial planner with Schwab Intelligent Portfolios Premium, said that mutual funds are managed by professional money managers for a fee.

“With actively managed funds, managers invest with the goal of beating a benchmark. Costs of actively managed funds are typically higher given the potential for outperformance,” said Richardson. “Most actively managed funds are mutual funds, but there are also many index mutual funds.”

5. Mutual funds experience capital gain distributions

One of the biggest differences between mutual funds and index funds is when taxable events occur for each.

“Mutual funds experience capital gains distributions which is a taxable event to an investor (even if the shareholder has not sold any of their shares) while ETFs typically do not,” Richardson explained. “Mutual funds are required by law to make capital gains distributions to shareholders.”

“The distribution represents the net gains from the sale of the investments throughout the year in the fund,” she added. “Since ETFs are typically passive investments that track an index, an investor typically does not realize a taxable event until they sell their investment.”