Active Investment or Passive Investment

Today the investors have a variety of options to invest their money. For those who have little knowledge of investor market may consider mutual funds as an option. Mutual funds are categorized under two major heads-Active Funds and Passive Funds.

To understand the type of funds let’s get to know the terminologies further:

Active Funds are managed by the fund manager. To pick profitable investments and to execute a stock that outperforms the fund’s index is the main task of the fund manager. Fund managers not only buy, sell and hold to attain maximum gain but also do analysis and research for the same aim in mind. That’s why they charge relatively high fees. Investment decisions are taken by the fund managers and they do the trading of stocks as well.

Passive funds on the other hand are based on the sole motto of tracking a market index to fetch maximum gains by a fund. Hence the fund manager is not actively involved here, making passive funds an easier option to invest in. An investor with almost zero knowledge about funds can opt for this, as there is no need to do any research as to the best performing fund or so.

Difference between Active and passive funds

One major difference between the active and passive funds is the difference in their expense ratio.  In case of passive fund, the fund manager doesn’t monitor the fund, resultantly lesser fees. This makes it a very popular kind of fund in India. Index funds lower the expense ratio.

But in case of actively managed funds a lot of research is required on the part of managers. The managers invest in a way so that they achieve maximum gains based on market performance. An active fund may charge 1.25% of investments as compared to 0.25% in case of any passive fund.

In case of an active fund, efficient fund managers try to find good quality companies. The portfolio will be structured so that profits get maximized. A well-diversified portfolio evades all the adversities. The cost of managing funds may be more in case of a well weighed, actively managed fund but they ensure higher returns to have the edge on its costs. Not just costs, the fruits of consistently managed funds should also prevail over ‘what if the same amount was invested in passive funds.’ however maximization of returns cannot be guaranteed intermittently. To beat the index is sometimes a tough task. Past success stories seldom repeat themselves in future.

Passive funds are often index oriented and hence the major shortcomings they face are:missing the high growth opportunities and failure to judge distinct framework.

Any investor before selecting the option needs to be well acquainted with the mechanism. Cost vis a vis benefits in case an active fund and vice a versa in case of a passive fund.

If we look at history, we cannot say which schemes have been on top consistently in last ten years. Sometimes in order to earn more, the risk factors are not taken account of. There is no process nor individual nor philosophy which could point out with a certainty to beat the market in the long term. When the things going to play out are not known, naturally the investors will stick to passive funds. However, to be an index investor or not is purely left to one’s own discretion. India is witnessing more efficient markets with volumes going up, people who invest are also going up making it a competitive market for portfolio management. 

Have a look at the following table showing a comparison of active vs passive funds over a 2–3-year historical trend.

The best rewarding Index fund trends (historical).

Screengrab from ET Money

Top two active fund trends (historical)

Screen grab from Groww

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Krishna Rath is a SEBI Registered Investment Adviser, and since 2015 has been educating netizens on investments and insurance. Krishna is a fee only SEBI RIA and is Odisha's first SEBI RIA. With background in IT, Krishna is changing the advisory space with new innovations in AdvisoryTech.

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