Mutual fund investments have become quite popular in India. As an investor, while investing in mutual funds, it is essential to understand their portfolios and how they are managed. Portfolio management means how the fund manager buys and sells underlying assets ( equity, debt, gold, etc.). Therefore, mutual fund portfolios can be actively managed or passively managed. In this article, we will understand the differences between Passive vs Active Mutual Funds.
Difference Between Passive Funds and Active Funds
The following are the differences between Passive vs Active Mutual Funds.
|Parameters||Passive Mutual Funds||Active Mutual Funds|
|Meaning||A passive mutual fund merely tracks the market index of NIFTY or SENSEX or other smaller indices in the same composition where the fund manager does not manage the fund on a regular basis. For ex: ETF or index funds.||An active mutual fund is created around a theme in which the fund manager actively manages the mutual fund portfolio by buying and selling the underlying stocks based on the market scenario. For ex: equity funds or debt funds|
|Fund Manager Strategy||The fund manager only copies the movement of the benchmark indices.||The fund manager actively manages the fund composition at their own discretion.|
|Expense Ratio||The expense ratio for these funds does not go beyond 1.25%||The expense ratio ranges from 0.5% to 2.5% depending on equity or debt composition.|
|Performance Goal||Fund Manager aims to match/ replicate the performance of the market index. For ex: an index fund will replicate the performance of the S&P 500.||The fund manager aims to outperform the broad market index called the benchmark. For ex: an equity fund will attempt to outperform S&P 500|
Which is Better for Investment?
Passive and active mutual funds are more like investment strategies with different features rather than good or bad, fund categories.
It entirely depends on the investor’s profile to invest in any of these funds. An active mutual fund tends to outperform the index where the fund manager and their team constantly conduct research to select stocks.
Also, they use various technical and fundamental analysis tools for in-depth research. Furthermore, the fund manager proactively decides to buy or sell stocks depending on market conditions. Therefore, active mutual funds have higher costs involved because of a higher number of trades executed and getting a fund manager’s expertise.
On the other hand, in a passive mutual fund, the fund manager does not trade actively as the investment is made in stocks comprising the index and in the same proportion as the benchmark index. Therefore, the expenses can be lower as there is no specific research team required. Also, the risk involved is lesser when compared to active mutual funds.
While investing in mutual funds, it is vital to check the fund’s past track record, tenure and performance of the fund manager and the fund investment strategy.
Also, a blend of active and passive investment strategies can work well for long term investors. Investors with high-risk tolerance can consider investing in active mutual funds, whereas investors with a low-risk tolerance level can consider investing in passive mutual funds.
However, you can choose to build your portfolio on a strategy that best suits you based on your financial goals, investment duration and understanding of risk.