Many people have both mutual funds and index funds in their 401K plans.
When trying to decide what to pick with retirement plan contributions Carl Carlson, CEO of Carlson Financial said ordinary investors should just invest in index funds, but why is that?
Carlson said mutual funds are professionally managed while index funds are passive and just track an index. You can expect that the professionally managed mutual funds will have much higher fees and other costs.
There are disclosed costs and hidden costs with mutual funds. Disclosed costs can be front-end loads, back-end loads, purchase fees, redemption fees, the expense ratio, which includes operating costs, management fees, 12b-1 distribution fees and admin costs. What you won't see printed anywhere are: transaction costs, tax inefficiency costs, market movement costs and the cost of cash drag. Carlson said, many mutual fund costs are pushing 4%, though you might only see an expense ratio of 1% or even lower.
Carlson said if mutual funds do a lot better then in theory they may be worth it but the hard part is identifying which mutual funds will outperform.
Research shows that of the mutual funds that outperformed their benchmark for the last 3 years, only 5% of them will continue to outperform for the next three years, and it gets worse over longer periods of time.
You end up paying a higher cost, but for what? Carlson said for those prices, most people will be better off holding the less-expensive index funds.