Hedge Funds vs. Mutual Funds: Which Is a Better Investment? (2024)

  • Investing
  • Mutual Funds

Your net worth could determine which is right for you

ByKent Thune

Updated on November 15, 2021

Reviewed by

JeFreda R. Brown

Hedge Funds vs. Mutual Funds: Which Is a Better Investment? (1)

Reviewed byJeFreda R. Brown

JeFreda R. Brown is a financial consultant, Certified Financial Education Instructor, and researcher who has assisted thousands of clients over a more than two-decade career. She is the CEO of Xaris Financial Enterprises and a course facilitator for Cornell University.

learn about our financial review board

Fact checked byKyra Baker

Hedge Funds vs. Mutual Funds: Which Is a Better Investment? (2)

Among the investment products to choose from, hedge funds and mutual funds are two options that may seem attractive. Both funds provide the benefits of diversification through access to a pool of investment funds. But hedge funds are designed to target high-income investors. This means they come with higher fees and minimum investment requirements.

Once you understand these and other basics, you can decide if hedge funds or mutual funds are best for your personal investment objectives. Learn more about the differences and decide which is right for you.

What's the Difference Between Hedge Funds and Mutual Funds?

Hedge FundsMutual Funds
Typically actively managedMay be actively or passively managed
Typically a higher barrier to entryTypically accessible to any investor
Higher expensesLower expenses
Potential for more consistent returnsPotential for higher upsides and harsher downturns

Management Style

When investing in hedge funds or mutual funds, investors do not choose the securities in the portfolio; a manager or management team selects the securities. Hedge funds are usually actively managed. This means that the manager or management team can use discretion in the security selection and the timing of trades.

Mutual funds, on the other hand, can be actively managed or passively managed. If it is the latter, the mutual fund manager does not use discretion in security selection or the timing of trades; they simply match the holdings with that of a benchmark index, such as the .

Accessibility

Hedge funds and mutual funds both have certain limitations on investing. These could be minimum initial investments, for instance. But hedge funds are not as accessible to the mainstream investor as mutual funds. Some hedge funds require that the investor have a minimum net worth of $1 million. These are often much higher than those needed for mutual funds.

Some mutual funds will accept any amount of initial investment. Plus, none of them have net worth requirements.

Expenses

Hedge funds typically have much higher expenses than mutual funds. For example, hedge funds often have expenses that exceed 2.0%, On the other hand, most mutual funds have expenses that are 1.0% or below.

Note

Hedge funds may also take a cut of the profits before passing them along to the investors.

Performance

Hedge funds are designed to produce positive returns in any market environment. This is the goal even in recession and bear markets. However, because of this defensive nature, returns may not be as high as some mutual funds during bull markets.

For example, a hedge fund might produce a 4%–5% rate of return during a bear market; at the same time, the average stock fund may decline in value by 20%. During a bull market, the hedge fund might still produce low single-digit returns. The stock mutual fund could produce high single- or double-digit returns.

Over the long run, a low-cost stock mutual fund would most likely produce a higher average annual return than a typical hedge fund.

Which Is Right For You?

The average investor will not have a high net worth or the minimum initial investment needed to invest in hedge funds in the first place. For most people, a diverse portfolio of mutual funds and/or exchange-traded funds (ETFs) is a smarter choice than hedge funds.

This is because mutual funds are more accessible. They're also cheaper than hedge funds. Plus, long-term returns can be equal to or higher than those of hedge funds.

The Bottom Line

Hedge funds and mutual funds are structured in very similar ways. They pool funds from investors; then, they invest in a wide range of securities under the management of a professional.

Beyond those basic similarities, there are vast differences in goals, costs, and even in who is allowed to invest.

Hedge funds offer the potential for steady returns that outpace inflation while minimizing market risk. But most people will find they are better served by mutual funds.

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Sources

The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.

  1. Office of Investor Education and Advocacy. "Hedge Funds."

  2. Office of Investor Education and Advocacy. "Mutual Funds."

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As an investment enthusiast with a deep understanding of financial markets and products, I'm here to shed light on the article titled "Your net worth could determine which is right for you" by Kent Thune. My expertise in this field is substantiated by a comprehensive grasp of the concepts discussed in the article and my ability to translate complex financial information into accessible insights.

The article delves into the choice between hedge funds and mutual funds, providing valuable insights into their differences, management styles, accessibility, expenses, and performance. Let's break down the key concepts:

  1. Hedge Funds vs. Mutual Funds:

    • Management Style:

      • Hedge Funds: Typically actively managed, allowing discretion in security selection and timing of trades.
      • Mutual Funds: Can be actively or passively managed, with passive funds tracking benchmark indices.
    • Accessibility:

      • Hedge Funds: Typically have a higher barrier to entry, often requiring a minimum net worth of $1 million.
      • Mutual Funds: Generally more accessible, with some accepting any initial investment and no net worth requirements.
    • Expenses:

      • Hedge Funds: Generally have higher expenses, often exceeding 2.0%, and may also take a cut of profits.
      • Mutual Funds: Tend to have lower expenses, usually 1.0% or below.
    • Performance:

      • Hedge Funds: Aim for positive returns in any market environment, with a defensive nature that may result in lower returns during bull markets.
      • Mutual Funds: Exhibit varying returns, potentially outperforming hedge funds during bull markets.
  2. Which Is Right For You?

    • The article suggests that the average investor, lacking the high net worth required for hedge funds, may find mutual funds more suitable.
    • Mutual funds are highlighted as more accessible, cost-effective, and capable of delivering comparable or higher long-term returns.
  3. The Bottom Line:

    • Both hedge funds and mutual funds pool funds from investors and invest in a range of securities managed by professionals.
    • Despite structural similarities, there are substantial differences in goals, costs, and eligibility for investment.
    • Hedge funds may offer steady returns with lower market risk, but mutual funds are deemed more practical for most investors.

In conclusion, my expertise in investment strategies and financial products enables me to distill the complexities presented in the article, making it easier for individuals to navigate the decision between hedge funds and mutual funds based on their unique financial circumstances and goals.

Hedge Funds vs. Mutual Funds: Which Is a Better Investment? (2024)
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