Do you currently have money in a 401(k) or 403(b)? If so, most of your hard-earned dollars are probably invested in mutual funds. As a rule of thumb, investing your money in a mutual fund is better than stashing all of your cash in a single stock or bond. After all, its better to diversify your investments to reduce your risk, which is why mutual funds arent an awful investment, but I believe they arent the best investment.

About a year ago, I met Andrew Hallam, a mid-30 year old millionaire that did not acquire his wealth with a high-paying job or a glamorous business venture. Nope, hes making his millions with index funds on a teachers salary. I read his book, Millionaire Teacher and I was immediately convinced that Index Funds were the way to go with my investments as well. Over the course of 2012, my index fund investments have averaged over 14% growth.

Mutual Funds the not so great investment

Like I said in the first paragraph, mutual funds are definitely safer than piling all of your money in one stock, but there are many reasons why you might want to shy away from these investments. Lets quickly dig into these reasons.

1) High Fees

Mutual Funds are a conglomerate of many stocks of the same nature. There are mutual funds for restaurants, real estate, crude oil, tech companies pretty much anything you can think of. Theyre good because by owning a small share of many companies, your investment becomes safer. Theyre bad because there are many employees of this mutual fund that are paid to try and beat the market. And, who do you think pays for these employees salaries and the building theyre working in? You do! with your 1.5% fees that you pay on your investment account each year, you are keeping this mutual fund in business. And, whether you realize it or not, these fees are eating up your investment profits!

2) Broker Fees

Many of you have Financial Advisors that help you invest for the future. Did you know that these advisors/brokers get paid from mutual fund companies to push their investment fund? Its in your advisors best interest not to make you a bunch of money for your future, but to push a product (the mutual fund) that pays the most into their own pocket. On top of that, you are paying your broker a fee each year to handle your investment accounts for you, even if you lose money.

3) Sub-par performance

Many Mutual Funds believe they can beat the market. Some do for a short period of time, but overall, it has been confirmed (by Andrew Hallam in fact ) that over the long haul, Index Funds have outperformed Mutual Funds. So, if you are investing in Mutual Funds, you are actually earning less money per year, and youre paying a higher fee!

So What Are Index Funds?

Just like Mutual Funds, Index Funds are a conglomerate of different stocks, but instead of having a team of employees trying to beat the market, Index Funds are set up to mimic a specific index, like the S&P 500, the Nasdaq, or the Dow Jones Industrial Average. Since they arent managed every second of the day, they have extremely low fees (like 0.09% instead of 1.2% in a common mutual fund). Also, they are much simpler to understand and purchase, which means that theres no need for a broker (eliminate the broker fee). And, as I just stated, they have historically earned more than the average mutual fund! All signs point toward Index Funds for me, how about you?

Mutual Funds vs. Index Funds For The Long Term

The fees of 1.2% just seem so small dont they? Is there really that much difference between paying 1.2% for a mutual fund vs. 0.09% for an index fund? Lets test out an example and find out!

Lets assume that youre 35 years old and plan on retiring when youre 65. Youve already acquired $100,000 in your retirement account and have just decided to let the interest earn you the rest of your income until your retirement years. If you put your money into a mutual fund that earns an average of 14% each year, and has a fee of 1.2%, how much will you have after 30 years?

Mutual Fund Results $4.6 million

Index Fund Results $6.3 million

Now, lets say your index fund investment equals the mutual funds (even though its historically more) at 14%. With a fee of only 0.09%, lets see how much youll earn over the course of 30 years compared to the $4.6 million in the mutual fund.

The results are in. That seemingly miniscule percentage difference impacted your retirement fund in a huge way! I mean $1.7 million huge! If I had the choice between $4.6 million and $6.3 million, Id take the $6.3 million. Wouldnt you? I suggest that you take a serious look at your retirement accounts and see if index funds are right for you!

What do you think about Index Funds vs. Mutual Funds?

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