Trading stocks is often one big guessing game, and although experienced and educated investors do have the upper hand, nobody has any guarantees. Diversification is key, and the easiest way to do this is through mutual funds. Many markets experts simply believe that over time, the stock market is stable and will continue to increase, so buying shares of strong companies at a low price is the best strategy. Enter index funds.
Mutual funds are pools of investors' money invested into a variety of stocks or other securities instruments. When investing in a mutual fund, the investor has interests in all the stocks the mutual fund owns. The mutual fund itself is divided up into shares that the investors own. Each mutual fund has its own strategy and goals in terms of how the fund managers pick stocks to include.
Index funds are similar to mutual funds except that they don't follow a particular strategy -- the stocks in the fund closely mirror those of a specific stock index, such as the Standard and Poor's 500 index or the Dow Jones Industrial Average.
Both mutual and index funds can come with charges, or in "no load" varieties, which means that the investors don't get charged extra fees when the fund makes transactions. Mutual fund managers decide when to buy and sell stocks to meet their objectives, whereas index fund managers buy and sell based on the activities in the index that they are following. Mutual funds are usually categorized into a particular grouping such as aggressive growth or value, and you can track share prices in daily listing in financial publications such as The Wall Street Journal or Morningstar.
There are several benefits of both mutual and index funds. The first, which applies to both, is diversification. Having your money spread out over a variety of different stocks helps to increase the potential for gain while minimizing risk. If the market tends to rise, most diversified portfolios will rise along with it; it just depends on how much. Mutual funds try to beat the market, while index funds try to track it. Another benefit is having someone else pick the stocks for you, for free. This is great for the novice investor or the risk-averse. A major benefit of mutual funds is the potential to beat the market and see high returns, while a benefit of index funds is the conservative nature and the steadier, tortoise-style growth.
All stock investments have risks, the main one being the potential for loss. Neither mutual or index funds can guarantee you any returns on your investments. Mutual funds are somewhat riskier than index funds depending on the strategy of the stock picking. Fees can also add up for mutual funds that charge them.
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