How To Choose Between Active And Passive Mutual Funds?

Okay, you must have heard that passive funds have beaten active largecap schemes in the last one year. Then you must have also heard that in developed markets like the USA, passive funds are the preferred method to invest in the stock market. 

So, what is a passive fund? A passive fund, as the name suggests, follows a passive investment strategy – it just invests in an index. Its portfolio will reflect the constituents of the index in their exact proportion in the index. 

The idea behind the investment strategy is the theory that it is not possible to beat the market consistently for a very long period. So, it is better to invest in the index and just relax. It would save you money and time. And the gains made by the broader market would be reflected in the relevant index. In short, it is a lazy man’s strategy to earn money from the stock market. 

Active funds, on the other, try hard to beat the index. The active fund manager puts in a lot of effort to pick quality stocks on the hopes of outperforming the index. Some stocks always perform better than others. So, if the fund manager manages to pick stocks that can deliver super normal returns, the scheme might outperform the broader market. 

However, as said before, the extend of outperformance has been diminishing in developed markets. In some developed markets, the passive strategy has convincingly won. Due to this, most investors choose an index fund or exchange traded fund with lower fund managing fee to invest in the stock market. 

However, investment experts believe that India is still not in that league. They argue that a developing country like India would have many companies gaining prominence out of the blue. So, there will be many multibaggers available in the Indian market. Many mutual fund managers also firmly believe that active fund management would continue to remain relevant in the Indian scenario for at least a decade or more. 

Finally, if you want to eliminate the risk of a fund manager and opt for a lazy investment strategy, you may choose an index fund that follows a broader index for your long-term equity investment needs. Remember to choose a low cost scheme with marginal tracking error.