Index funds and managed mutual funds have one key differerence: The former are passive, while the latter are active. Like the Wall Street equivalent of Type A overachievers, managed funds have well-paid managers studying the stock market universe, deciding which equities (or other investments) to buy and sell, and when and in what proportion. Meanwhile, index funds -- the market's couch potatoes -- simply mimic a certain index. If 5% of the index is made up of stock in Carrier Pigeon Communications (Ticker: SQAWK), then 5% of the index fund will be, too.
We tend to assume that index funds are passive, since there's very little decision-making going on. That's not quite true -- because the index itself is managed. It might not change too often, but its components can still get switched around from time to time. We recently got a fresh reminder of this reality when the venerable Dow Jones Industrial Average kicked out two companies, General Motors and Citigroup
No, no, anything but management!
Should you therefore avoid investment funds, since they bear the terrible stain of *shudder* management? Not at all. Investment thinkers from Fools to Warren Buffett have long suggested that index funds are perfect for most investors, since they deliver the market's average return at a low price.
Now, if you want to aim for a higher performance, you'll need to put your own thinking cap on and start managing your own money. You'll need to find top-notch managed mutual funds in which to invest, or a basket of solid and growing individual stocks -- or better yet, a combination of the two.
There's no shame in just opting for an index fund, though. Although they're not entirely passive, their dependability makes them great investments, especially if you don't have the time or inclination to search out better choices.
A manageable amount of further Foolishness:
Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article. Kraft is a former Motley Fool Income Investor pick. The Motley Fool is Fools writing for Fools.