Choosing between active and passive mutual funds is a key decision for any investor. Active funds involve a hands-on approach by fund managers who aim to outperform the market, while passive funds simply track an index, offering a low-cost and stable option.
This article discusses both types of funds in order to help you understand the process and identify which type of mutual fund would work best for you.
What Are Active Mutual Funds?
An active fund is a type of mutual fund managed by experienced professionals who aim to beat the market index.
These funds invest based on thorough research and analysis of potential opportunities. This also leads to higher costs compared to passive funds such as index funds that simply track the market’s performance.
Investors need to carefully assess the fund’s performance, its strategies, and their own risk tolerance before investing in an active fund.
Read: All you need to know about mutual fund investments in India
What Are Passive Mutual Funds?
Passive mutual funds aim to mirror the performance of a market index, such as Nifty or Sensex, to optimize returns. The portfolio of a passive fund directly replicates the composition and proportions of the chosen index, ensuring it moves in sync with market trends.
Unlike active funds, passive funds do not rely on a fund manager to select individual stocks, making them simpler and easier to track. Many investors choose passive funds to capture the overall market’s performance.
Their appeal lies in their cost-effectiveness, as they avoid the expenses linked to stock selection, research, and frequent monitoring.
What is the Difference between Active vs. Passive Funds?
Following are the key differences between active and passive mutual funds:
1. Nature of the Mutual Fund
In active mutual funds, the professional buys/sells assets, studies the market, and looks for opportunities.
In passive mutual funds, the role of a fund manager is minimal when selecting stocks and market timing, as the strategy aims to mimic benchmark returns by investing in assets in a similar proportion as in the index.
2. Expense ratio
Passive mutual fund schemes provide a cost-effective option for investors, as their expense ratios are typically lower than those of active mutual funds.
This is mainly because passive funds don’t involve the frequent buying and selling of securities like active funds do. Instead, they aim to replicate the performance of a benchmark index.
3. Return on Investment
Actively managed funds tend to be more volatile, as they rely on the expertise and insight of fund managers to achieve favourable outcomes. These funds primarily strive to outperform the benchmark and have the potential to offer higher returns.
Passive index funds aim to replicate the performance of a benchmark, delivering returns that closely mirror the total returns of the underlying securities.
4. Associated Risk
Active funds can present varying levels of risk depending on their type. For example, an active equity fund typically carries more risk than an active debt fund.
In contrast, passive mutual funds reduce unsystematic risks, such as stock selection and the choice of portfolio managers, by using a rule-based investment approach that aligns with the stock weights in the benchmark.
5. Flexibility
Active mutual funds offer significant flexibility as fund managers can adjust the portfolio in response to market conditions, economic trends, or individual stock performance. This enables them to seize opportunities and reduce risks.
However, passive mutual funds have limited flexibility, as they strictly follow an index. Adjustments occur only when the index itself changes.
Also read: Everything You Need to Know About Portfolio Management Services in India
Active Funds vs Passive Funds: Which One You Should Choose?
The choice between active and passive mutual funds depends on your investment goals and preferences.
Active mutual funds are managed by professional fund managers who aim to outperform a specific benchmark index by making strategic investment decisions. These funds can potentially offer attractive returns but come with higher fees and expenses due to the active management involved. Additionally, the performance of active funds can vary significantly based on the manager’s skill and market conditions.
On the other hand, passive mutual funds aim to replicate the performance of a specific index, such as the Nifty 50, by holding the same securities in the same proportions as the index.
These funds typically have lower fees and expenses since they require less active management. While passive funds may not outperform the market, they offer a more predictable and cost-effective way to achieve market returns over the long term.
So basically, the decision between active and passive funds should be based on your risk tolerance, investment horizon, and preference for potential returns versus cost efficiency.
Conclusion
Choosing between active and passive mutual funds depends on your financial goals and comfort with risk. Take time to assess your needs before making a choice. Remember, finding the right strategy can make a big difference in your investment journey and future financial success.Confused about where to invest? Book a call with Moat Wealth today.
