Aug. 11–Now that you have made back some of your losses from the stock market collapse, it might be useful to look at the differences between index funds, mutual funds, and hedge funds.

The index fund is the simplest. It’s a direct proxy for the stock market, or some subsection.

When you invest $1,000 in such a fund, the fund invests all the money in the stocks of its index. You’re making a bet on the index. The managers don’t have an opinion. They’re merely allocating your money according to a computerized weighting.

If the index goes up, you win. If it goes down, you lose. The bet is yours.

Because people tend to pile into indexes when they’re going up, and flee from them when they’re going down, the funds can have exaggerated momentum on both the up and the down side.

The Nasdaq went from 322 in 1990 to 5,132 in 2000, a heck of a ride. Then it plunged to 1,108 in 2002.

As it plunged, Congress never investigated the managers. You can’t sue a computer, even if it’s losing trillions of dollars. If you’re playing these funds, you have to remember, you’re the only one making an investment decision. The fund is just a computer program.

Mutual funds contend they’re managing your money, but they’re also a bullish bet on the market.

A fund’s charter is to invest in stocks that fit its discipline. Tech funds buy tech stocks. Income funds buy stocks with yields.

The managers try to pick stocks that will outperform, but they’re supposed to be almost fully invested. They keep cash like you keep money in a cookie jar.

This may sound like heresy, but mutual funds don’t try to make money. They try to outperform their benchmarks. If a tech fund is up 15 percent, but its competitors are up 25 percent, it’s doing badly. If it’s down 10 percent, but other funds in its benchmark are down 20 percent, it’s doing well. The manager’s job is to do the best within a specific investment style.

If you invest in a mutual fund, you are making the asset allocation decision. You are choosing to be exposed to the market and picking the style and manager you think will perform the best.

Hedge funds operate differently. Like mutual funds, they pick stocks. But unlike mutual funds, they also make market bets.

If they like the market, they can have lots of long investments — buying stocks, betting they’ll go up in price. If they don’t like the market, they can shift to shorts, betting the shares will go down.

They also use options and other techniques to limit risk.

Because they’re hedged, most of the funds tend to do relatively well when markets drop, and often underperform when markets rise.

If you are investing in a hedge fund, you aren’t making a bet on the market. You are instead making a bet on the manager. It is the manager who is making the bets on both individual stocks, and on the direction of the market.

Of course, because of their risk, most hedge funds require their investors be relatively wealthy and have a lot of money to invest, though these rules are starting to change.

I run a hedge fund, so I’m naturally prejudiced. But I believe that many people who are investing in indexes or mutual funds don’t recognize they’re making the market timing decisions.

If you want to make a pure bet on the market, pick an index fund.

If you want to bet on a particular sector or manager, pick a mutual fund.

If you want to let someone else time the market for you, go for a hedge fund, or mutual fund that’s allowed to short.

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