Investing is no longer exclusive to expert market players. In today’s times, Indians are more inclined towards investing in mutual funds to generate wealth in the long run and to attain their financial goals.
Amongst the initial decisions that an investor has to make is whether they should opt for active investing or passive investing. Both approaches are designed to increase capital but have different strategies. Knowing about them and their workings can help you effectively make an informed investment choice.
What is active investing?
Active investing has a fund manager picking securities and actively managing the portfolio with the goal of earning returns more than the market. Investment decisions are made on the basis of research, market conditions, and growth opportunities across different sectors and companies.
For instance, ICICI Flexicap Fund is an actively managed fund that allows investment in large-cap, mid-cap and small-cap stocks. Active investing provides the advantage of outperforming the market but depends on the fund manager’s skills and bears increased costs.
What is passive investing?
Passive investing is about trying to match the performance of a market index, not outperform it. These are funds that invest in the same securities and in the same proportion as the index that are tracked by them. This makes it a simple way to participate in the growth of the market.
Passive funds can usually boast lower expense ratios as they need a minimum amount of involvement from fund managers. For instance, Nifty 50 mutual funds are ones that follow the Nifty 50 Index and invest in the companies that are included in the index. This makes them a popular option for investors who want to diversify and want lower costs.
Active vs passive: Key differences investors should know
There are clear differences between active investing and passive investing in terms of how the portfolios are managed, the costs associated with each type of investing, and the returns that are expected from these two options. Knowing these differences can assist investors in selecting the strategy that suits their financial objectives and tolerance of risk.
Investment approach
Active funds are based on research and stock picking by the fund manager. Passive funds are not actively managed, but instead follow an index and reflect it.
Costs
Expenses are typically higher for active funds, given the research, analysis and portfolio management. Passive funds tend to be more inexpensive to run.
Return expectations
Active funds seek to outperform the market. Passive funds aim to mirror the performance and returns of the index they track, with a possibility of a slight difference.
Risk and volatility
Active funds’ performance is reliant on the actions of the fund manager. The performance of the underlying index is the main driver of passive funds.
Flexibility
The advantage of an active fund is that the fund manager can adjust the portfolio based on investment opportunities and market situations. Passive funds track a specific index, so they are only adjusted when the index itself is rebalanced.
Which approach is right for you?
An ideal option is certainly based on your investment objectives, risk appetite, and investment preferences. Active investing might be appropriate for investors who are confident in trusting their professional fund managers and are willing to accept the risk of higher returns.
On the other hand, passive investing could be suitable for investors who want a low-cost, transparent, and long-term investment approach.
Moreover, many investors also mix both approaches to have a well-balanced portfolio that gains from both broad exposure to the market and active management.
Final thoughts
When it comes to wealth creation, there are 2 different routes: active and passive investing. Active funds are designed to outperform the market with professional management, whereas passive funds are designed to track market performance at lower costs.
There is no universal answer to which is the best investing approach. The ideal approach is certainly the one that fits your financial objectives, investment timeline and risk tolerance.
