When it comes to investing in Active vs Passive funds, one of the most important decisions you’ll need to make is whether to choose an active or passive funds.
While both types of funds have their advantages and disadvantages, the choice ultimately comes down to your investment goals, risk tolerance, and personal preferences.
In this blog, we’ll take a closer look at active and passive mutual funds, and explore the key factors you should consider when making your investment decisions.
(A) What are Active and Passive Mutual Funds?
(i) Active Funds
Investments are buy and sell to optimize earnings in actively manage funds. The fund manager is in charge of conceptualizing and selecting suitable investments to execute a stock that outperforms the benchmark or index for the fund.
Hence, to decide how assets are bought and sold, a fund manager needs information, in-depth research, and comprehensive know-how. Even if the fund manager is in charge of making his own decisions, they should be in line with the mutual fund investor’s investment objectives.
Having said that, selecting an active fund option could be expensive. The rationale is that fees are associate with a fund manager’s competency. In fact, The expenditures ratio typically fluctuates between 0.08 and 2.25%, depending on the equity-debt direction of the fund.
(ii) Passive Funds
The portfolio management of passively managed funds is not actively handled by a fund manager. Instead, they just try to match the performance of a benchmark. Unlike active funds, their passive counterparts employ a buy-and-hold strategy in an effort to mimic the performance of a market index.
The ETFs are manage passively. Exchange-Traded Funds are not governed by the fund manager, but with ETFs, the fund monitors and tracks index movement.
SEBI makes the decisions regarding ETFs, not fund managers. The index returns are change into the returns of the ETFs. Charges made under the expense ratio, management fees, additional fees, or dividends may differ.
(B) Advantages & Disadvantages
(i) Active Mutual Funds
(a) Advantages of Active Mutual Funds
Active mutual funds have the potential to outperform the market due to the fund manager’s active research and selection of securities, as well as the flexibility to adjust their portfolio holdings based on market conditions and analysis of investment opportunities.
Another advantage of active funds is the potential to provide downside protection in Falling markets. Active fund managers can adjust their portfolio holdings to reduce exposure to high-risk securities or industries, which can help protect the fund’s value during market downturns.
(b) Disadvantages of Active Mutual Funds
One of the main disadvantages of active mutual funds is the higher fees charge by the fund manager. In addition, since active funds are manage by humans, there is always the risk of underperformance due to errors in judgment or poor investment decisions.
Another disadvantage of active funds is the potential for overtrading. Active fund managers may take frequent buy and sell decisions, which can result in higher trading costs and lower returns.
(ii) Passive Mutual Funds
(a) Advantages of Passive Mutual Funds
Passive mutual funds have lower fees than active funds because they simply track an index, requiring less active management from the fund manager. This can help investors achieve their long-term investment goals more easily.
In fact, Passive funds are simple and have fewer investment risks as the fund manager tracks an index, making them an excellent option for hands-off investors or those new to investing.
(b) Disadvantages of Passive Mutual Funds
Passive mutual funds are inflexible and can’t adjust their portfolio holdings based on market conditions or investment opportunities. This limits their potential for outperformance, especially in rapidly changing market environments.
Passive funds can have tracking errors, deviating from their intended index, resulting in lower returns over the long term.
(C) Active Vs Passive Funds – Which one you should choose?
It relies totally on the investor’s aim and its risk tolerance. If an investor, for instance, desires more returns, he may choose an active fund based on his ability to take risks.
In the same way, a risk-averse investor who searches for stable income may opt to invest in passive funds. The difference between active and passive funds is more because of their features rather than any fund.
It is best to consult an financial advisor if you don’t know what is best for you, he will suggest you the best fund, which suits your financial risk profile.
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References: valueresearchonline.com, Industry’s Publications, News Publications, Mutual Fund Company.
Disclaimer: The report only represents personal opinions and views of the author. No part of the report should be considered as recommendation for buying/selling any stock. Thus, the report & references mentioned are only for the information of the readers about the industry stated.