Investment crossroads: Active vs Passive investing
3 min read
Apr 12, 2024
India's mutual fund industry has achieved a significant milestone, with its assets under management (AUM) surpassing Rs 50 lakh crore in December 2023. This achievement highlights the increasing popularity and trust in mutual funds among investors in India. For newcomers to mutual funds, the multitude of available options can be overwhelming.
Embarking on your investment journey in mutual funds often leads to a crossroads: whether to invest in active or passive funds. This decision can significantly influence your financial future. In this article, we will explore the fundamental differences between active and passive investing strategies and help you determine which one to select.
Active funds
Active investing involves actively buying and selling securities to generate returns that surpass the benchmark or index. Mutual funds following an active investment strategy aim to outperform their benchmark indices by selecting undervalued stocks or capitalising on market trends.
This strategy appeals to investors who seek higher returns and are willing to navigate higher risks. However, success in active investing demands extreme patience, thorough research, precise timing, and a tolerance for the market's inevitable volatility.
Benefits
- Potential for higher returns: Fund managers actively strive to outperform the market, potentially yielding higher returns compared to passive strategies during specific market conditions.
- Flexibility: Fund managers have the flexibility to adjust portfolios based on market conditions, economic trends, or specific investment opportunities.
Limitations
- Higher costs: Active investing typically have higher expense ratio due to factors such as ongoing research, analysis, and trading activities.
- Performance risks: Despite efforts to outperform the market, active fund managers may underperform due to poor investment decisions.
Passive funds
Passively managed funds aim to replicate the performance and portfolio composition of a specific index. They do not involve active stock selection or market timing and therefore do not require continuous buying and selling of securities. These funds are well-suited for first-time investors or those with a conservative investment approach. Index funds and exchange-traded funds (ETFs) are common examples of passive investment vehicles.
Benefits
- Lower costs: Passively managed funds have lower fees and expenses since they require minimal research and trading activity.
- Less volatile: Passive funds are relatively less risky than active funds because they do not involve unsystematic risks like stock selection.
Limitations
- Limited potential for outperformance: Passive funds aim to match market returns, which may result in underperformance compared to active funds.
- Less flexible: Passive funds accept market fluctuations without making adjustments to their portfolios.
Active vs passive funds: A summary
| Criteria |
Active funds |
Passive funds |
| Objective |
Outperform benchmark indices |
Replicate benchmark index returns |
| Costs |
Higher expense ratio, portfolio turnover |
Lower expense ratios, minimal turnover |
| Flexibility |
Asset allocation, sector / stock selection, market timing |
Constrained by benchmark composition |
| Risk Management |
Wrong selection of stocks/ sectors |
Market risk, tracking error |
Also Read: How to invest in Mutual Funds in 7 easy ways
Which one should you choose - Active or passive investing?
Choosing between active and passive investing depends largely on your investment objectives, risk tolerance, time horizon, and preferences. If you believe in the potential to outperform the market and are comfortable with paying higher fees for active management, then actively managed funds may be suitable for you. However, if you prefer a low-cost approach that offers broad market exposure, passive funds are a better fit. A combination of both active and passive strategies may be appropriate for a well-diversified investment portfolio.
Accessing a wide range of mutual fund options has never been easier, thanks to Axis Bank's internet banking or mobile banking app. With just a tap, you can explore a plethora of mutual funds and make informed investment decisions conveniently from the comfort of your home.
Disclaimer: This article is for information purpose only. The views expressed in this article are personal and do not necessarily constitute the views of Axis Bank Ltd. and its employees. Axis Bank Ltd. and/or the author shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.
Mutual Fund investments are subject to market risk, read all scheme related documents carefully. Axis Bank Ltd is acting as an AMFI registered MF Distributor (ARN code: ARN-0019). Purchase of Mutual Funds by Axis Bank’s customer is purely voluntary and not linked to availment of any other facility from the Bank. T&C apply.
