Active funds and Passive funds

Welcome to our Investor Education Originals series. In this video, let’s get to know Mutual Funds better. We will understand the difference between Active Funds and Passive Funds, and how to choose one.

“Mutual funds sahi hai,” we have heard this enough, but how do we know which mutual fund is the best? We’ll learn about the two types of mutual funds to make more informed MF investments.

The entire MF universe is divided between two types of mutual funds – active funds and passive funds. Fund manager plays an important role in active funds whereas they have to do the bare minimum in passive fund schemes.

Active Funds:

Every mutual fund scheme has one or two fund managers who select and deploy funds. When fund managers do active research to select stocks, that mutual fund scheme is called Active MF scheme. And since the fund manager plays a major role, the fund management fees are also high, and so is the expense ratio of that scheme. The major goal of an Active MF scheme is to generate alpha, which means generating more returns from broader markets.

Passive Funds:

Passive, as the name suggests, requires passive treatment by fund managers. They are also known as index funds. Passive funds or index funds are those that invest in the same companies that constitute an index. For example, the Nifty50 index fund invests in the 50 companies of the Nifty50 index invests. Since the fund manager himself is now selecting or deploying the funds, these funds are called passive funds. And hence, the expense ratio of an index fund is also lower. Passive funds earn nearly the same as what the underlying index earns. You generate average market returns by investing in passive funds.

Which one to choose – active funds or passive funds?

If you do not have the time and resources to select stocks or mutual fund schemes by yourself, you can simply choose different categories of index funds and create a diversified portfolio. Index funds help in DIY investing. If you are okay to pay a higher commission and let the fund managers invest in broader markets for extra returns, you can invest in active funds. However, do take the help of an investment advisor or mutual fund distributor while selecting active MF schemes.