Mutual funds, index funds, and ETFs explained for beginning investors. Index funds track market indexes with low fees, while actively managed mutual funds try to beat the market but usually don't. ETFs work like index funds but trade like stocks during the day.
What is a mutual fund? A mutual fund is simply a group of people banding together to invest their money together. By doing so, they enjoy a number of benefits, right? They get professional management. You get economies of scale, you get the benefits of government regulation, you get broad diversification, you also get daily liquidity. Passive management is where you just buy all the securities of a certain type, right? This is usually in proportion to some type of index or a list of all the securities. So all index funds are mutual funds, but not all mutual funds are index funds. In the early 90s, someone got the bright idea to allow investors to just trade their funds all day long while the markets are open. So those funds are called exchange traded funds or ETFs. All ETFs are a type of mutual fund. So sometimes people use the term mutual fund when they're referring only to traditional funds, including both open and closed. And that's kind of a non precise use of terminology that confuses lots of beginning investors.
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