NASAA Series 66 Uniform Combined State Law ExaminationInvestment Vehicle CharacteristicsEasy
A client is investing in a mutual fund that aims to replicate the performance of a specific market index, such as the S&P 500, by holding the same securities in the same proportions as the index. They are looking for low expense ratios and minimal portfolio turnover. Which type of pooled investment is the client likely considering?
- AAn indexed mutual fund.
- BA sector-specific mutual fund.
- CAn actively managed equity mutual fund.
- DA fund of funds.
Show answer & explanationAnswer & explanation
Correct answer: A. An indexed mutual fund.
An indexed mutual fund (or index fund) is passively managed and designed to track the performance of a specific market index. This approach typically results in lower expense ratios and minimal portfolio turnover compared to actively managed funds, aligning perfectly with the client's preferences.
Why the other options are wrong
- B. Sector-specific funds focus on a particular industry and may be actively or passively managed, but their primary characteristic is industry concentration, not necessarily low cost or index replication.
- C. Actively managed funds seek to outperform an index, leading to higher expense ratios and more frequent trading (higher turnover).
- D. A fund of funds invests in other mutual funds, leading to higher expense ratios (due to double layering of fees) and does not primarily aim for index replication.
Indexed Mutual Fund (Index Fund)
A type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the S&P 500. It is passively managed, aiming to replicate index performance rather than outperform it.
- Lower expense ratios than actively managed funds.
- Lower portfolio turnover, leading to fewer capital gains distributions.
- Offers broad market exposure and diversification.
Memory trick: Mutual funds: baskets of investments, managed differently.