What is an index fund and how does it differ from an actively managed mutual fund?

• A. An index fund aims to replicate a market index's performance passively, with low fees; an actively managed fund seeks to outperform the market through skilled stock picking, usually with higher fees.
• B. An index fund always beats the market; an actively managed fund never does.
• C. An index fund is a type of bond fund; an actively managed fund is a stock fund.
• D. Index funds have higher fees than actively managed funds.

Answer: (A)

Index funds are designed to mirror the performance of a market index by holding the same securities in the same proportions, so their returns track the index rather than reflect a manager’s stock-picking. Because they’re managed passively, costs are typically low, leading to lower fees and less frequent trading. In contrast, actively managed mutual funds try to beat the market through research and stock selection, which involves more trading, higher research costs, and a higher fee structure. While an active fund can outperform in some periods, the added costs mean that, on average, many do not beat the index after fees over the long term. So the key difference is tracking the index with low costs versus attempting to outperform it with higher costs and more active management.