There are two types of people in the world - those who go with the flow and let life take over and others who take matters into their own hands. You could be either one of these. There is no right way of living as long as you do what makes you happy. Mutual funds also follow these two approaches. In the world of investing, they are known as active and passive investing. Keep reading to find out the difference between passive and active funds.
What are passive funds?
Passive funds track a benchmark index and try to mimic its performance. Passively managed funds include passive index funds, exchange-traded funds (ETFs), and Fund of funds investing in ETFs. These funds follow a benchmark and aim to deliver returns in tandem with the benchmark, subject to expense ratio and tracking error. Passive funds allow investors to have direct exposure to the benchmark indices.
What are active funds?
Active funds employ a fund manager who participates in all buying and selling decisions. The fund manager manages the Fund with active investing by studying the market forces and the economy.
Passive vs active funds: Differences between the two
Here are the differences between active and passive investing:
1. Nature:
Active investing is a hands-on approach where the fund manager is fully involved in the investment process. The professional buys stocks, sells them, studies the market, looks for opportunities, and more.
In passive investing, on the other hand, the fund manager has a negligible role in selecting stocks and market timing as the scheme seeks to replicate the benchmark returns by investing in securities in the same proportion as in the index.
2. Expense ratio:
Passive mutual fund schemes offer a low-cost option to investors as the expense ratio is generally lower than active mutual funds. This is primarily because passive mutual fund schemes do not require active buying and selling securities like active funds. They try to imitate the benchmark.
3.Returns:
Passive index funds follow a benchmark and deliver returns similar to the total returns of the securities represented in the benchmark prior expense ratio and tracking error. However, actively managed funds can be relatively more volatile. They leverage the knowledge and experience of the fund manager to generate favourable returns. They primarily aim to beat the benchmark and may offer higher returns.
4. Risk:
Passive mutual funds eliminate unsystematic risks like stock picking and portfolio manager selection via rule-based investing as per the weight of stocks in the benchmark. Active funds may be relatively riskier depending on the type of Fund. For instance, an active equity fund can carry a higher risk than an active debt fund.
Active funds vs passive funds: What to choose?
You can consider either, depending on what you are looking for. Ideally, a mix of both can offer good diversification. However, the precise allocation can only be decided based on your financial goals and risk appetite.
FAQs
What is passive investing?
Passive investing is an investing style where the mutual fund scheme follows the underlying benchmark index and tries to mimic its performance. Passive investing does not include actively buying and selling securities to outperform the benchmark. These funds follow an index and deliver returns in line with the benchmark's performance.
How to invest in passive mutual funds?
You can invest in a passive mutual fund in a few simple steps:
- You can invest through a distributor.
- Alternatively, you can invest by directly visiting the Asset Management Company's website (AMC).
- Passive funds, such as Exchange Traded Funds (ETFs), provide liquidity as they can be easily bought and sold like any other stock on the exchange during market hours at real-time prices.
How to invest in mutual funds online?
You can invest in mutual funds online through a broker or directly visit the Asset Management Company's website (AMC). Online investing is simplified as you can browse different funds, compare expenses and objectives, check the portfolios, etc., and then decide.
Investment in ETFs can be made via stock exchange during market hours at real-time prices.
