Life puts you in different situations. At times, you want to take full charge of things. At other times, you may like to go with the flow. These two approaches are important in the investment world, too, particularly when it comes to mutual fund investments. There are passive funds that follow a passive investment strategy and active funds that follow an active investment strategy. Let’s understand these strategies and the real winner in the ‘passive fund vs active fund’ discussion.
What are passive funds?
Passive funds are mutual funds that track and imitate a particular index. They invest in the same securities that constitute the benchmark and in the same proportion. The aim is to mirror the performance of the index instead of outperforming it. Thus, the fund manager has a limited role to play. Exchange-traded funds and Fund of funds are some examples of passive funds.
What are active funds?
Active funds, as the name suggests, are mutual funds that are actively managed. The fund manager proactively studies the market, conducts extensive research, and uses his discretion to choose securities that can help meet the fund’s objectives. They actively buy and sell securities with a view to maximising the fund’s returns.
Now that you have a basic idea of these two types of funds let’s understand their differences in detail.
Passive fund vs active fund – differences explained
Investment strategy
Active funds follow an active investment strategy that involves frequent buying and selling of securities. On the other hand, passive funds follow a passive, long-term investment strategy that involves buying and holding securities in accordance with the underlying index.
Fund manager’s role
The fund managers are actively involved in the management of the fund in the case of active funds. They select the securities and also decide on their weights based on market conditions. But passive fund managers do not have this flexibility. Regardless of the market conditions, they must ensure that the allocation and composition of the portfolio match that of the underlying index.
Cost
Active funds have comparatively higher operating expenses and management costs than passive funds because of the active ongoing trading. Passive funds imitate an index and, thus, have a lower expense ratio.
Performance goals
Active funds aim to beat the benchmark returns, whereas passive funds align their returns with that of the benchmark.
Investment risk
Active funds tend to be riskier than passive funds because of the ongoing trading. Passive funds believe in the buy-and-hold approach, thus involving comparatively lower risk.
How to choose between the two?
If you are unsure about the answer to ‘passive fund vs active fund’, analyse your financial goals, risk appetite, return expectations, and other similar factors. Alternatively, you can also opt for a balanced approach and have both active and passive funds in your portfolio.
To sum it up
Mutual funds offer variety. You can not only pick between asset classes but also choose between active and passive fund management styles. Now that you know how active and passive funds work, you can pick the one that best suit you.
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MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS. READ ALL SCHEME-RELATED DOCUMENTS CAREFULLY
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MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
