Active vs passive funds: which one is right for you?

Active vs passive funds: which one is right for you?

Passive vs Active funds which one should you pick

Passive funds have been gaining a lot of popularity in recent times. Investors from the developed countries usually invest more in passive funds. In India, the number is much lower, but the awareness around this is increasing gradually. Data from the Association of Mutual Funds in India reflect that net assets under management of passive schemes stood at Rs 4. 72 trillion, as of December 2021, compared to Rs 2.94 trillion in December 2020 – an increase of 60.5 per cent. 

Most Indian investors are currently active investing in active funds. If you plan to have exposure to passive funds, you need to understand the difference between these two. Once you understand the differences, you can then decide which option is better for you.

What are Active Funds?

When a mutual fund is created, it is created around a theme. For example, mutual fund A could be in the large-cap category. It means that scheme A will predominantly invest in large-cap companies. There are many large-cap companies across India. The fund manager of fund A has to brainstorm and decide which large-cap company he is going to pick in the scheme. He decides when to sell existing stocks and bring in a new stock in the scheme. Also, how to use the funds that are coming from the investors – what percent to keep as cash and what to invest. In short, he actively manages the fund. Such funds are called Active Funds. 

What are Passive Funds?

A passive fund tracks a market index – it could be NIFTY or SENSEX or some other smaller indexes. You know that NIFTY, for example, tracks the top 50 companies across India. A passive fund can follow the NIFTY50 – if a company goes out of it, the fund takes out that company and brings in the replacement. These are passive funds as the fund manager does not manage the fund on a regular basis. 

Related: All You Need to Know About NIFTY50

What is the difference between active and passive funds?

The primary difference between the two must be clear to you from the above definitions. Let us look at another major difference. Since passive funds do not have the active participation of a fund manager, the fee (expense ratio) is far less compared to active funds. In active funds, there is a lot of research that goes into finding the best stocks for investment and that involves a high fee.

Related: Active Vs. Passive Investing: Know the Difference

Which is a better option?

If you are looking for companies across a variety of sectors where the scope of growth is higher, you can consider investing in active funds. Passive funds usually track large companies where the potential growth is limited.

In line with the above point, the risk is lower in the passive funds. Since they track big companies, they are more stable, and hence even in the volatile market they don't fall much. Active funds may have many stocks that are of high risk. Hence, they may fall more in the volatile market. If you don't want to take high risks, passive funds are a better option for you.

In an ideal case scenario, it is suitable for investors to have both options in their portfolios. Depending on your risk profile, you can decide what should have a higher allocation in your portfolio – active or passive funds. Aggressive investors should have a higher allocation in active funds, while one should have a higher allocation in passive funds if you want to be in a safe space.

We hope that the information will help you decide the best fund to invest in.

Related: Why Actively Manged Funds Continue to Outweigh Passively Managed Funds?

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