It’s not a choice between active funds or passive funds ⁠— you should have a right mix of both in your portfolio

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It’s not a choice between active funds or passive funds ⁠— you should have a right mix of both in your portfolio
BCCL
  • There are two types of mutual funds one can invest in—active funds and passive funds.
  • Funds that involve the active role of fund managers to earn high returns are active funds and funds who mirror returns of a particular index are passive funds.
  • It is better to have a combination of both funds in your portfolio as one will fetch you higher returns than market and the other may give you relatively lower but stable returns.
Anyone who has started researching investment in mutual funds must have heard of two topics—active and passive funds and wondered what it means. Here is a simple answer to that.

Funds that involve the active role of fund managers to earn high returns are active funds. Here are some examples of the best performing funds in this category in the last one year.

Examples of top performing equity related active fundsReturn in last one year
ICICI Prudential Commodities Fund160%
Quant Small Cap155%
Kotak Small Cap122%
Nippon India Small Cap Fund115%
L&T Emerging Businesses113%
Source: Value Research

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The funds that mirror returns of a specific index like BSE Sensex, Nifty 50 or S&P BSE 250 Small Cap index are passive funds.

Examples of top performing equity related passive fundsReturn in last one year
Nippon India Index Fund - Sensex Plan39.90%
LIC MF Index Fund Sensex39.10%
ICICI Prudential Nifty Index Growth42.80%
UTI Nifty Index Fund43.40%
Franklin India Index Fund Nifty Plan42.20%
Source: Fincash

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Active fundsPassive funds
Intends to outperform returns of a specific index set as benchmarkIntends to match or mirror returns of a specific index
Fund managers play a huge role in decision making of selling and buying of stocksDo not involve any human intervention and sticks to the stock list similar to the index that is being followed
Attract higher charges called expense ratio for fund manager skillHave lower expense ratio as no special skill is involved here

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Active funds are for investors who want to earn more returns than the market and are willing to take a certain amount of risk

When I say XXX is an active fund it means the underlying assets i.e equity, debt etc of the mutual fund are being bought and sold by the fund manager. Here the fund manager has the right to pick and choose his/her investments with the aim to deliver higher returns than a chosen benchmark.

The fund manager will actively buy, hold and sell stocks to try to achieve the return promised to investors.

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The idea behind actively managed funds is to allow ordinary investors to invest money under a professional stock picker who manages their money. When things go well, actively managed funds can deliver performance that beats the market over time. However, the returns are not guaranteed.

Meanwhile, passive funds are suitable for investors who are looking for simple and low risk investment vehicles

There is relatively lower risk in passive funds as here the underlying fund is just replicating the stocks of a particular index one has invested in. For example, there are passive funds that replicate the large cap, mid cap, and small cap indices. For some debt space, funds replicate performances of 10-year government securities and so on.

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One of the benefits of a passive fund is that it attracts a lower expense ratio as the fund manager does not use his skill or knowledge to pick stocks. He simply replicates the returns of an index.

Generally, the difference between active and passive funds can be as high as 1-1.5% which eventually impacts the in hand profit of the investor.

You would now ask active or passive?

It is better to have a combination of both funds in your portfolio as one will fetch you higher returns than market and the other may give you relatively lower but stable returns.
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