If you're saving for retirement in a Roth IRA, index funds and actively managed mutual funds are two of your investment options. Both help diversify your portfolio, but they have different investment objectives, management styles, and—esp♍ecially—costs.

Roth IRA Investment Options

One of the benefits of a Roth IRA, as with a 澳洲幸运5官方开奖结果体彩网:traditional IRA, is the wide variety of investments you can hold in the account. While your investment options for employer-sponsored plans like 401(k)s are limited to those offered by the plan, you can invest in everything from 澳洲幸运5官方开奖结果体彩网:individual stocks to real estate in a Roth. Two popular investments are actively managed 澳洲幸运5官方开奖结果体彩网:mutual funds and 澳洲幸运5官方开奖结果体彩网:index funds.

Investment Objectives for Managed M🅺utual Funds and Index Funds

Both actively managed 澳洲幸运5官方开奖结果体彩网:mutual funds and index funds are made up of portfoꦺlios of securities, which might include stocks, bonds, or some combination of the two. But their objectives can differ.

Managed mꦑutual funds seek to beat the returns of a related benchmark🍨 index. They are managed based on a specific investment objective. For example:

• Growth funds seek capital appreciation. These funds put a large percentage of assets into stocks because stocks offer higher potential rewards. As such, they tend to be riskier.
• Income funds try to provide investors with a stable income. They invest in lower-risk investments such as corporate bonds, government securities, and certificates of deposit (CDs).

An index fund, on the other hand, is a type of mutual fund that attempts to match a specific market index, such as the 澳洲幸运5官方开奖结果体彩网:S&P 500 or the 澳洲幸运5官方开奖结果体彩网:Russell 2000 Index. It foꦫllows its 🌼benchmark index no matter what the market is doing. When the index goes up or down, so does an index fund that tracks it.

Management Styles for Managed Mutual Funds and ꦿIndex Fu🎃nds

The key difference between these two types of funds is how they are managed. Actively managed mutual funds, as the name indicates, are 澳洲幸运5官方开奖结果体彩网:actively managed. That means there's a team of investment professionals who make the decisions. They actively 🐟pick the fund's holdings and adjust them as needed—often on a daily, or even hourly, basis.

By contrast, index funds are 澳洲幸运5官方开奖结果体彩网:passively managed. The investme🦋nts are automated to track the underlying index, so they don't require as much buying and selling. Because n𝔍obody actively manages the holdings, their performance is based solely on the price movements of the securities in the index.

Comparin♛g Costs of Managed Mutual Funds and Index Funds

The fees you pay each year to own a particular mutual fund are known as the fund's 澳洲幸运5官方开奖结果体彩网:expense ratio. I𒈔t measures how much a fund spends on management and other cꦦosts, expressed as a percentage of its total assets.

You'll typically pay more for an actively managed mutual fund because the team running the show has to be paid and its more frequent trading will also rack up costs. The average expense ratio for an actively managed mutual fund in 2023 was 0.65%, but it can be lower or higher. In general, the expense ratios on managed mutual funds have been declining in recent years, due in part to competition from index funds.

Index funds have expense ratios, too. But since these funds aren't actively managed, their costs tend to be much lower. The average expense ratio for an index fund in 2023 was 0.05%.

Even though the average fees for the two types of funds differ by less than 1%, that difference can have a huge impact on your Roth IRA balance over time. Suppose you invest $7,000 (the maximum Roth IRA contribution in 2024 for anyone under age 50) in a mutual fund that earns 8% a year and has a 1% expense ratio. After 40 years🏅, your i✅nvestment would be worth $104,821.

But what if you invested the same amount of money in an index fund with a 0.05% expense ratio? Assuming the same 8% return, your investment would be worth $149,281 after 40 years—a $44,460 difference. And that's just with one year's worth of Roth IRA contributions.

And something else to keep in mind: If you invest in an actively managed fund at 1% while a comparable index fund charges 0.05%, the fund managers have to beat the market by at least 0.95% every year to make up for that added expense. It's possible for an active fund to have an amazing run that beats an index over several years. But historically, those funds have always come back down to Earth.

Managed Mutual Fund or Index Fund ꦡfor Your🎶 Roth IRA?

Here’s a quick comparison chart 🌞of actively manage𝔍d mutual funds and index funds.

The Bottom Line

For now, index funds are the clear winner for Roth IRAs because of their low fees. However, as investors shift toward lower-cost funds, industry competition is driving down mutual fund expense ratios overall. On average, expense ratios for managed mutual funds have declined substantially for more than 20 years, according to the Investment Company Institute, a trade group. Wh💖o knows what will happen in the next 10 or 20 years?