When it comes to investing in a mutual fund, the question of active basically comes down between an active mutual fund or a passive mutual fund. Whether you are a new investor or a seasoned professional, understanding the difference between an active mutual fund and passive mutual fund is critical to help inform you while making investing choices. Here, we will discuss what is an active mutual fund, what is a passive fund, how passive funds work, the pros and cons of active funds, and how to determine which one is best for your financial goals.
What is an Active Mutual Fund?
An active fund manager invests in an active mutual fund after market analysis, economic conditions, and company analysis. Its aim is to outperform the benchmark index by selecting securities with higher growth opportunities.
Example: If the benchmark index is Nifty 50, an active fund manager will try to pick stocks more good than the Nifty 50 average.
Key Active Fund Characteristics
Human Expertise
Industry experts analyze companies, industry forces, and market performance for active funds. Professional guidance guides investment, with an aim of beating benchmarks and generating enhanced risk-adjusted returns.
Objective
The underlying goal of active funds is to beat the market average. The managers desire higher returns by selecting stocks and industries strategically instead of mirroring a market index.
Flexibility
Actively managed funds would also allow portfolio managers to make take action much faster than passive funds would allow. As the market shifts, managers can quickly pivot portfolios across sectors, industries or stocks and respond to opportunities while dodging disasters.
What is a Passive Fund?
A passive mutual fund (usually an ETF or index fund) simply tracks an index. It will copy the performance of the benchmark index without attempting to surpass it.
Index Fund Definition: Index fund is a passive fund that replicates the performance of an index of the market like Nifty 50 or Sensex.
How Passive Funds Work
Passive funds purchase identical stocks and proportions as the chosen index. Lacking active decision-making, there are fewer management fees.
Example: A Nifty 50 Index Fund contains all 50 of the stocks of the Nifty index in the identical proportion of the index.
Active vs Passive Mutual Fund Comparison
Factors | Active Mutual Funds | Passive Mutual Funds |
Style of Management | Actively managed by fund managers | Passively tracks an index |
Objective | Be better than the benchmark | Same as the benchmark |
Costs | Higher expense ratio | Lower expense ratio |
Returns | Can potentially yield greater returns | but with risk Similar to market performance |
Risk | Greater due to human decision-making | Lower as it follows the index |
Active Funds’ Advantages and Disadvantages
Active Mutual Funds’ advantages
Potential for Higher Return
Active funds attempt to outperform the market. Experienced fund managers select quality companies, sectors, or themes and provide their investors a promise of better performance than simple index management.
Adaptive Strategy
Portfolio management would have constant rebalancing of their portfolios due to changing markets. This flexibility enables them to mitigate risks, play new opportunities, and remain active to changing economic, political, or industry issues.
Best for Risk-Takers
Active funds are suitable for investors who are ready to accept market volatility for larger returns. Individuals with medium to high risk tolerance tend to opt for active methods in order to achieve their long-term financial goals.
Disadvantages of Active Mutual Funds
Too High Costs
Active funds are more expensive because they carry management and research costs, which are detrimental to total investor return.
No Outperformance Guaranteed
Even skilled management will not necessarily cause active funds to outperform benchmarks, so investors will not necessarily get the higher returns they are paying for.
Manager-Driven Risk
Portfolio stability and returns are threatened by the decisions of the fund manager. Unwise stock or sector bets can damage portfolio stability and returns.
Benefits of Passive Investing
Low Costs
Low-cost funds come at low costs because they replicate indexes, and thus investors hold more of their gains in the long term.
Clear Structure
Replication reproduces the index, and investors can clearly view where their money is placed.
Wide Diversification
Investors are exposed to many sectors and companies, and thus less risk than through individual stock or active fund strategies.
Consistent Returns
Passive funds are duplicating index returns, offering consistent and guaranteed returns with no danger of active management choices.
Should I choose Active or Passive Funds?
The questions is always: Should I choose active or passive funds? The answer will depend on so many factors: your time horizon, your risk tolerance, and your goals.
Active Funds are good for you if you want the opportunity for over average returns and can tolerate volatility.
Choose Passive Funds If: You prefer low-cost investing with secure, market-matching returns.
Conclusion
With active vs passive mutual funds, there isn’t a right or wrong answer. Active funds can provide more gain, but will come with higher cost and risk, while passive funds are more financially secure and safe and track the markets as intended. The best option is to mix active and passive together with a blend of both, depending on your risk appetite and investment objectives.
Being an AMFI Registered Mutual Fund Distributor at VSRK Capital, we help the investors make such choices with the focus of professional advice that is tailor-made according to the needs of the client.
FAQs
Active funds are operated by fund managers who attempt to outperform the market, while passive funds simply track the benchmark index.
Yes, passive funds are safer since they replicate a total market index. They can't outperform the market, however.
No, although active funds attempt to outperform passive funds, a majority of studies show that, over the long term, passive funds perform as well, or better, after fees.
Both do the trick. A portfolio comprised of passive and active funds, in turn, on the basis of risk tolerance and goals, is most likely to succeed.
