Methodology of Mutual Funds

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    Measurement

    • An investment index is a basket of securities that is tracked to measure the performance of a particular type of asset. For example, the Russell 2000 is an index that tracks the smallest 2,000 publicly traded stocks in the United States and is considered a proxy for the small-business market in the United States. Indexes exist for all sorts of assets in all parts of the world. Every mutual fund measures its performance against a benchmark index, but funds use different methodologies to perform optimal returns against them.

    Active Management

    • An actively managed fund employs a fund manager that uses statistical analysis and insight to pick stocks that will outperform the index it is being compared to. For example, the Charles Schwab Core Equity fund is an actively managed fund that is benchmarked to the S&P 500 index, which measures the performance of large corporate stocks. This fund has a manager that tries to pick stocks from this index that are underpriced and will outperform the index in aggregate. Actively managed funds have higher expense ratios to pay for manager salaries and overhead.

    Passive Management

    • A passively managed fund is a mutual fund that tries to mimic, not beat, the performance of an index. They're also known as index funds. For example, the Vanguard 500 Index fund is a passively managed mutual fund that tracks the S&P 500. Instead of deliberately picking certain stocks, the fund attempts to hold stocks from the S&P 500 in the same proportion as the index, so that their returns are nearly the same. The advantage of index funds is that they incur less fees, which have a large impact on investment performance over time.

    Investment Strategy

    • A trade off all mutual funds make is whether to invest for income or growth. A mutual fund that attempts to achieve maximum growth is more likely to invest in stocks, particularly small ones, which have high levels of volatility but tend to achieve higher returns over long periods of time. A mutual fund that invests for income is likely to invest in bonds, and large company stocks. These assets have less price appreciation but pay more in dividends and interest income.

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