Both index funds and actively managed mutual funds pool money from many investors to buy a diversified basket of assets, but they differ in strategy and cost.
An index fund simply tracks a market index, such as the S&P 500, buying the same securities in the same proportions. There’s no attempt to beat the market – just to match it as closely as possible.
An actively managed mutual fund has a manager or team making decisions about which securities to buy and sell, aiming to outperform a benchmark. This active management comes with higher fees, since it requires more research and trading.
Over long time periods, a majority of actively managed funds have historically underperformed their benchmark index after fees, which is a major reason index funds have grown so popular with everyday investors.
That said, some actively managed funds do outperform, particularly in less efficient markets. For most beginner investors, low-cost index funds offer a straightforward way to get diversified market exposure without picking individual winners.