What is Active and Passive investment?

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The investment market these days has numerous schemes to choose from. People who are new to the world of investing might find it challenging to decide which investment scheme to opt for. To make their life easier, aspiring investors are requested to keep a financial goal in mind and then plan their investments accordingly. Having a defined financial goal might help you identify how long your investment horizon needs to be if you and how much corpus you must invest primarily to increase your chances of achieving your ultimate financial goal.

Generally, new investors who are completely oblivious to the investment industry seeking capital appreciation through equity investments consider investing in mutual funds. This cancels out on the possibility of exposing your finances directly to the dangers of the equity market. Mutual fund investments are usually diversified as they collect money from investors sharing common investment objective and invest this pool of funds in assets across various sectors and industries.

However, did you know that mutual funds are further categorized as active funds and passive funds? If you wish to understand more about active and passive mutual funds, continue reading:

What are active funds?

Actively managed funds generally charge relatively high fees, because together with analysts and researchers, fund managers actively buy, hold, and sell stocks to achieve maximum capital appreciation. The main job of a fund manager managing an active fund is to analyze, interpret data, and pick sensible investments, which intend to execute in stocks that outperform the fund’s specified benchmark or index. Any fund which is actively managed by a fund manager is known as an active fund. The fund manager actively takes decisions on how to invest a fund’s corpus.

What are passive funds?

A passive fund is a type of fund that conscientiously tracks a market index to allow a fund to fetch maximum gains. Here, the fund manager does not actively participate or choose on behalf of the fund. He does not decide which stocks the fund will comprise of, which is the case in an active fund. This allows investors to invest in a passive fund or index fund easier. The fund will track the index, and there isn’t anyone manually picking funds on their behalf. Also, index funds are a good way for investors who are new to the investing world because you do not need to research and know about the best performing fund.

Passive funds or index funds are a considerate option for those investors who are seeking capital appreciation through long-term investment. As stated earlier, index funds have the same composition as the underlying index, and hence moves up and down in tandem with the underlying index. So if you invested in an index fund that tracks S&P BSE TRI-Sensex, if this particular index goes up, this would have a positive impact on your index funds. At the same time, if the market is in turmoil, this may result in drop the index dropping points, and this, in turn, might have a negative impact and passive or index fund you invested in.

What is the difference between passive funds and active funds?

Active funds Passive funds
In case of active funds, the fund manager takes the effort and uses his years of industry experience to analyze and make active calls on behalf of the fund. As mentioned earlier, passive funds do not have any kind of active participation of a fund manager.
Due to the active participation of the fund manager, the fees charged by active funds are pretty high. Due to the absence of the fund manager’s active participation, the fees charged by passive or index funds are comparatively low, and this is what makes them less expensive.
Active funds tend to have a high expense ratio. That’s because, in actively managed funds, financial managers have to do a lot of industry research and accordingly move funds in various securities based on market performance. This makes active management costlier as there is a lot of research and other work put in towards the investment. The reason for passive funds to gain popularity among investors in India recently is their low expense ratio.
The involvement of a fund manager in an active fund is always high. The involvement of a fund manager in an index fund is comparatively less. That’s because index funds are designed to mimic the indices.

So have you decided whether you want to invest in an active fund or a passive fund? We hope this article helps you in understanding the difference between an active investment and a passive investment. Investors are always requested to keep their long term investment objective in mind before making any type of investment decision. Also, having a diversified mutual fund portfolio might even help them balance the overall risk.

Mutual fund investments can be one way to get a step closer to your ultimate financial goal. Make sure that you do enough research and invest in a fund that shares the same investment strategy as yours.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.

Photo by Clark Tibbs on Unsplash

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