The Pros And Cons Of Active Vs. Passive Index Mutual Funds

Keywords: index mutual funds, Mutual Fund, MF Calculator

Mutual Funds are now among the most sought-after investment options for both experienced and novice investors. However, before investing in any funds, it is essential to understand their types, advantages and drawbacks. There are two primary methods for managing such funds: actively and passively.

The decision to opt for actively managed funds or passively managed funds depends on several key factors, including your investment style, risk tolerance, and financial objectives. In this article, we shall compare and develop a deeper understanding of active funds and passive funds, their pros and cons, and which one is the right investment option for you.

Table of Contents

What are Active Mutual Funds?

An active mutual fund refers to a fund where the pooled money of all investors is managed by fund managers who make all the buying, holding and selling decisions with respect to the invested securities. The primary goal of such management in funds is to outperform market indices.

The following are some pros of going for actively managed funds:

Potential for Enhanced Returns: You can leverage the experience of seasoned fund managers to outperform the market, delivering improved returns.
Expert Management: Fund managers conduct thorough research and adapt holdings in response to market dynamics.
Adaptability: Managers can adjust strategies in response to market fluctuations to minimise losses.

Active mutual funds entail the following cons:

Increased Expenses: Actively managed funds typically have higher management fees and expense ratios, which enable them to afford experienced fund managers.
Performance Volatility: Although they charge more, not every active fund reliably outperforms its benchmarks.
Reliance on Managers: The performance of an active fund is heavily influenced by the manager’s expertise and approach.

What are Passive Mutual Funds?

Passive funds are those funds that a fund manager does not actively manage; they simply imitate a market index, such as the NSE NIFTY or BSE SENSEX. They are usually referred to as index mutual funds. The primary objective is not to surpass the index, but to replicate it and provide commensurate returns.

These are a few pros of going for passively managed funds:

Lower Expenses: As passive funds simply track an index and do not rely on fund managers, their management fees tend to be much lower.
Transparency: It’s straightforward to understand your investments, as the fund replicates a publicly available index.
Consistent Returns: Passive funds offer market-aligned returns, which have been observed to yield strong returns over the long term.
Ideal for Beginners: Perfect for investors seeking a straightforward, low-effort investment strategy.

Here are some cons of going for passive mutual funds:

No Outperformance: Passive funds are designed to match the market rather than surpass it.
Complexity in Adjustments: During market downturns, passive funds often struggle to adjust their holdings to mitigate losses, thereby limiting their flexibility.

Which One is Right For You?

Having understood the pros and cons of both funds, these considerations can help you decide the right pick for you.

If you want potentially higher returns but can’t dedicate the required time and effort, and are willing to pay a little extra for professional management, an active fund may suit you.
If you prefer lower costs, consistent growth, and minimal involvement, passive funds are a more appropriate choice.

You can use tools like the MF calculator to assess the returns from both kinds of funds, compare them with your financial goals and make the decision accordingly.

Conclusion

Investing in the funds is a wise decision, but also a nuanced one. It is essential to understand the nuances of various types of funds to select the most suitable one for your needs. If you want to leverage the expertise of fund managers, consider investing in active funds. Whereas if you seek consistent returns at a lower cost, passive funds are for you.

Bajaj Finserv not only helps you take the right call regarding your mutual fund investments but also provides you with numerous schemes to choose from. You can manage your portfolio digitally from a single platform and make seamless improvements.