Personal Finance

Differences Between Active & Passive Funds: Which Mutual Fund is better for you, where to invest money? know here

October 19, 2024

Differences Between Active & Passive Funds: Most investors who invest in mutual funds do not know about this. Even if their portfolio is worth lakhs.

Who is not aware of the name of Mutual Funds (Mutual Funds India) today. Perhaps you too must have been investing in mutual funds for the last several years and must be happy to see your money growing year after year. But if someone asks you which fund do you invest in – Active fund or Passive fund? Then perhaps you do not have the answer to this question, maybe you do not even know what active funds or passive funds are. Most investors who invest in mutual funds do not know about this. Even if their portfolio is worth lakhs.

Let us tell you today what Active funds and Passive funds are and why it is important for a common investor to know about them.

Two ways of investing in mutual funds

Actually, in the last few years, mutual funds have become very popular among the people. People are adopting the method of investing in mutual funds to get better returns. In particular, there are two ways of investing in mutual funds – active funds and passive funds.

What are active funds?

Let us first tell you about active funds. As its name suggests, active means active. Active funds are managed by experts. Here expert means fund manager. Strategy is made before investing. Fund managers take decisions related to buying and selling on a regular basis. From an investor’s point of view, active funds are preferred more because they are managed by industry experts. The decision of where to invest, in which stock, when to exit from which stock is taken by the fund manager.

Active Mutual Funds are expected to give better returns than the index i.e. the market, because it is managed by fund managers. However, fund managers charge the investor for this, so the Expense Ratio of active funds is higher than passive funds. Because a large panel of experts works behind that fund.

In simple words, the purpose of an active fund is to perform better than the market index. However, note that there is no guarantee that this will happen. Active funds may have better risk management than passive funds. Because fund managers can quickly understand the changes taking place in the market. But, this does not mean that they are completely risk free. Equity mutual funds, debt mutual funds, hybrid funds or fund of funds etc. come under the category of active funds.

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What are passive funds?

Let us now talk about passive funds. For the last few years, investment in passive mutual funds has been increasing continuously. Passive funds are also a means of investing in mutual funds, which track the market index or a particular market segment. Like active funds, in passive funds the fund manager does not decide which companies will be included in the fund. Investing in passive funds is easy. Because passive fund investors do not need to research the best performing funds.

Advantages and disadvantages of passive funds

Let us tell you that an investor invests money in a passive fund when he wants his return to be according to the market. These funds are low-cost funds. Because there is no expense in their stock selection and research. New investors entering the market, especially young investors, prefer this type of fund more. The biggest reason for this is the good returns of passive funds. Passive funds track a benchmark index and try to meet the performance of that index.

Compared to active funds, there is less volatility in them. Index funds are considered a good investment option for those who do not have time to track the market. Investors have to pay less expense ratio in passive funds as compared to active funds. Index funds, exchange traded funds (ETFs) come under the category of passive funds. Apart from this, ETFs and index funds are available for many categories including gold, commodities, banks, healthcare.

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Differences Between Active & Passive Funds

As we have told you, in active funds, the fund manager decides in which stocks of which sectors the money should be invested, whereas passive funds invest in market indices, such as 30 companies of Sensex or 50 companies of Nifty, in proportion to their weightage. In this way, the role of the fund manager in passive funds becomes very limited. Hence their management fees are also low. In the last few years, the number of passive fund investors has increased rapidly in small cities and towns.

If you want to invest but you do not have much knowledge about investing or you have very little knowledge, then in such a case investing in mutual funds through passive fund funds will be a good option for you. Passive funds are for such investors who do not want to take much risk and do not want to get into the hassle of choosing which fund to get better returns.

(This is just general information. Take expert advice before making any kind of investment.)

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Differences Between Active & Passive Funds: Which Mutual Fund is better for you, where to invest money? know here