Mumbai: As a mutual fund investor, you should be very clear about two distinct categories of mutual funds: Active Mutual funds and Passive mutual funds. Choosing between active or passive mutual funds can be confusing if you are a new mutual investor in a quest for wealth creation. Let’s understand what they are:
What are active and passive mutual funds?
Passive Funds
Under passively managed mutual funds, an investor’s investment portfolio is passively managed, which doesn’t involve active fund manager decision-making. Passive investing is attractive to investors looking for simplicity, efficiency, and a way to avoid the challenges of choosing funds. Passive funds replicate the benchmark index and are generally less volatile than active funds, making them a good choice for new investors who want to prioritise safety over high returns. Passive funds include Index funds and ETFs, which replicate their underlying benchmark by investing in similar companies that make up the benchmark index.
For example, a Nifty50 index fund or ETF invests in the 50 companies of Nifty50, while a Sensex index fund or ETF invests in the 30 companies of Sensex. ETFs and Index Funds are available for various categories, including gold, commodities, banks, healthcare, and others.
Active Funds
Equity mutual funds, debt mutual funds, hybrid funds, and funds of funds all fall under actively managed funds. When it comes to active mutual funds, the fund manager of these schemes conducts extensive study and analysis to develop the fund’s strategy. They have to constantly take an active call on regular buy-sell decisions of investments. The table below shows the critical difference between active and passive mutual funds.
Understand the risks
Today, the allure of passive funds like ETFs and index funds is so strong that it’s easy to overlook the risks involved while investing in them, just like with mutual funds. However, one shouldn’t ignore the tracking error. Tracking error refers to the difference between the index fund’s returns and those of the index it tracks. The lower the tracking error, the better the passive fund’s performance. The expense ratio cannot be overlooked when it comes to active funds. Active funds have a higher expense ratio than passive funds. The expense ratio for active mutual funds ranges from 0.80 per cent to 2.25 per cent, while the expense ratio for passive funds can go up to 1 per cent.
Active funds usually fall under the moderate to very high-risk investment category, whereas passive funds fall under the low to moderate-risk category. An investor with a high-risk appetite who wants to earn a double-digit return can opt for active funds such as equity mutual funds. An investor looking for stability in their income and risk-averse can opt for passive funds such as index funds. It’s not advisable for investors to have their entire portfolios consist solely of passive funds. Only a small portion of the total portfolio should be allocated to these types of funds.
Again, the allocation of active and passive funds in your portfolio should be determined by your risk tolerance, investment horizon, and expected return. If you’re unsure about how to make these decisions on your own, you can seek advice from a financial planner.
Before investing in actively or passively managed funds, it’s essential to understand critical factors such as risk appetite, potential returns, and time horizon to achieve the best results. Business Business News – Personal Finance News, Share Market News, BSE/NSE News, Stock Exchange News Today
