Investors, especially beginners, often tend to hear the terms active funds and passive funds while starting their SIP in mutual funds. However, most of them are not fully aware of how these two mutual fund investment approaches actually differ. Both types of mutual funds aim to grow your money, yet the way they do it is what sets them apart from each other. Understanding the distinction can help you pick the style that suits your goals, risk appetite, and expectations from the market.
What Are Active Mutual Funds?
Active mutual funds or active MF employ fund managers to execute all the purchase and selling decisions. They try to outperform the market. They thoroughly study company reports, track industry trends, meet management teams, and make buying and selling decisions based on this research and judgment. Their aim to beat the benchmark index is crystal clear.
Features Of Active Funds:
- Involves human decision-making skills as the fund manager decides what to buy or sell.
- The expense ratio is generally on the higher side because of the involvement of research teams and constant ongoing analysis.
- A skilled manager can outperform the index during certain market cycles.
- Purchase decisions entirely depend on the manager’s skill; wrong calls can significantly pull down returns of your mutual fund SIP.
What Are Passive Mutual Funds?
Passive mutual funds have an entirely different approach. Instead of trying to beat the market, they simply try to mirror or copy a benchmark index such as the Sensex or the Nifty 50. So, what they do is buy the same stocks and in the same proportion as the benchmark index and try to stay close to it.
Features of passive funds:
- The fund does not involve any active decision-making as it does not attempt to predict winners.
- Since there is minimal research and trading, the expense ratio for an SIP investment is much lower.
- The goal is not to outperform the index, but to stay in line with it.
- Performance depends on the index and not individual judgment.
How Do Costs Differ?
The difference in the price of active and passive funds is even greater than some suspect. Active funds can be much more expensive in terms of expense ratio, as it depends on analysts, fund managers, and research teams. Passive funds, conversely, are meant to be low-maintenance. The savings in cost can be felt in the long-term returns, where the difference will be felt particularly in the SIPs with a duration of several years.
How Do Returns Compare?
Returns depend largely on market conditions:
- During bull markets, the passive funds tend to stand still as most of the stocks are on the upswing.
- Through turbulent or unpredictable periods, a skilled fund manager can assist an active fund to manoeuvre risks more than the broad index.
Not every active fund does, however, perform. Some find it very difficult to constantly outperform their benchmarks, and this is why passive funds have become popular among long-term low-cost investors.
Many investors combine both types. They use passive funds listed on a mutual fund app for stable, long-term growth and active funds for specific themes or categories where active management could add value. This mix gives them the steadiness of index investing and the potential upside of selective active strategies.