Mutual Fund Investment: Should you choose Active or Passive Funds?

As these funds have moderate returns, they could be equal to the benchmark’s returns or lesser but cannot beat it.

While investing in mutual funds, there are various ways the money can be managed – actively or passively. Managing a portfolio means understanding how the underlying assets such as gold, equity, debt, etc. are being bought and sold by the fund manager.

In the case of an actively managed fund, a fund manager has more involvement in the decision-making process, whereas, in passively-managed funds, it is not in the hands of the fund manager to decide the movement of the underlying assets. Simply put, with actively managed funds the fund manager is more active in looking after and choosing which stocks and bonds go in and out of a mutual fund portfolio and when.

Active vs Passive Investing

Actively Managed Funds – For both passive and active investments, the strategies are unique in their ways. For instance, experts say if an investor wants a little more than what the benchmarks are offering, then he/she should opt for actively managed funds. This is because one of the main objectives of actively managed funds is to beat the returns of Sensex and Nifty. Hence, the role of a fund manager, who uses his/her experience, and knowledge for market research to generate better returns. Fund managers diligently change the fund’s composition at their discretion.

Having said so, choosing an active fund option could be expensive. It is so because the expertise of a fund manager comes with costs. As an investor, you will have to pay charges such as expense ratios for the fund manager’s expertise and decision making. The expense ratio usually ranges from 0.08 to 2.25 per cent depending on the equity/debt orientation of the fund.

Additionally, the risk is also high with actively managed funds. As these funds generate higher returns, experts say the risk associated with them is also higher as compared to passive funds.

Passively Managed Funds – As compared to actively managed funds, the expense ratios of passive funds are way lower. Note that the expense ratio for ETFs cannot exceed 1 per cent as per Sebi regulations. For instance, while the expense ratio of the direct plan of HDFC Sensex fund is 0.2 per cent, the expense ratio of the direct plan of ICICI Sensex fund is 0.1 per cent as of July 16.

At the same time, experts say passively managed funds cannot beat benchmarks. As these funds have moderate returns, they could be equal to the benchmark’s returns or lesser but cannot beat it. Unlike actively managed funds, the fund manager here only copies the movement of the benchmark indices.

Which one should you choose?

Experts say there is no ‘good’ or bad between the active and passive investment strategy – it all depends on the investor profile. If as an investor you are looking for an actively managed fund, experts say to make sure that you can financially afford an active fund and that your risks and goals are in line. However, if you want the fund to simply map the benchmark without taking any risk, then passively managed funds could be ideal for you.

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