Which of the following best describes a key difference between a mutual fund and an index fund?

• A. Index funds can only be purchased by institutional investors, while mutual funds are available to individual investors.
• B. A mutual fund only invests in government bonds, while an index fund only invests in stocks.
• C. Mutual funds are not regulated, whereas index funds are strictly regulated by the government.
• D. A mutual fund is actively managed, while an index fund typically tracks a specific market index and is passively managed.

Answer: (D)

Verified step by step guidance

1. Step 1: Understand the concept of a mutual fund. A mutual fund is a type of investment vehicle where money from multiple investors is pooled together to invest in a diversified portfolio of assets such as stocks, bonds, or other securities. It is actively managed by professional fund managers who make decisions about buying and selling assets to achieve specific investment goals.
2. Step 2: Understand the concept of an index fund. An index fund is a type of mutual fund or exchange-traded fund (ETF) designed to replicate the performance of a specific market index, such as the S&P 500. It is passively managed, meaning it does not involve active decision-making by fund managers; instead, it aims to match the index's performance by holding the same securities in the same proportions as the index.
3. Step 3: Compare the management styles. The key difference lies in the management approach: mutual funds are actively managed, with fund managers making strategic decisions to outperform the market, while index funds are passively managed, aiming to track the performance of a specific index without attempting to outperform it.
4. Step 4: Evaluate the implications of active vs. passive management. Active management in mutual funds often leads to higher fees due to the involvement of fund managers and research teams. In contrast, index funds typically have lower fees because they require less active oversight and decision-making.
5. Step 5: Confirm the correct answer. Based on the definitions and differences explained, the correct answer is: 'A mutual fund is actively managed, while an index fund typically tracks a specific market index and is passively managed.' This highlights the fundamental distinction between the two investment vehicles.