If you are a first time mutual fund investor, you must know that mutual funds are broadly categorized as active funds and passive funds. There are a lot of strong opinions about both passive and active funds which sometimes might lead a new investor in a dilemma when deciding which mutual fund to invest in. Retirement planning is a long term goal which can be targeted through mutual fund investing. However, it is necessary to choose the right type of scheme to allow your money to compound over the years through systematic and disciplinary investing.
What is active and passive investing?
In active investing, the fund manager is actively involved in managing the mutual fund scheme’s investment portfolio. The investment objective of an actively managed fund is to invest in a diversified portfolio of securities and help the scheme outperform its underlying benchmark. This way of investing requires fund managers to possess deep understanding about the markets as they are expected to opt in and out of company stocks by predicting market movements. The fund manager along with the team of expert analysts and market researchers scrutinize and evaluate the hygiene of several stocks to determine which securities to buy or sell from time to time.
Passive investing on the contrary is exactly opposite of how active funds work. While active investing requires fund managers to constantly keep juggling between the underlying securities of the mutual fund portfolio, in passive investing there is very less active involvement. There’s very little active buying and selling in passive investing. Passive funds are designed in such a way that their main aim is to generate returns by replicating the performance of their underlying index with minimum tracking error.
Active funds v/s passive funds
| Particulars | Active funds | Passive funds |
| Expense ratio | The expense ratio of active funds is much higher as fund managers play a decisive role in ensuring that the scheme is able to achieve its investment objective | Since there is very little participation from the fund manager who is only involved in evaluating and reshuffling the portfolio, the expense ratio of passive funds is much lower |
| Investment objective | To earn capital appreciation by investing in a diversified portfolio of securities and active buying and selling of stocks as per changing market cycles | To earn capital appreciation by mimicking the performance of its underlying index with minimum tracking error |
| Investment approach | In multiple stocks across market capitalization depending on the nature of the scheme | Invests in multiple securities of its underlying index |
| Strategy | By constantly buying and selling stocks | By buying and holding on to the stocks |
Should you invest in active or passive funds for retirement goals?
To build a commendable retirement corpus, one must have a long term investment horizon and the willingness to be involved in systematic and disciplinary investing. Both active and passive funds can be an investment choice for targeting a long term goal like retirement planning. However, passive funds have a long expense ratio and are known to have a buy and hold investment strategy. This kind of investment approach is adopted by stock market investors as well. Investing in passive funds for building a retirement corpus can be a good idea as they have a low expense ratio and have the tendency of generating decent returns over the long haul. Whether one should invest in active or passive funds may also depend on how the investors want their portfolio to be handled. Those who seek professional management may opt for active funds whereas people who do not want to much interference in their portfolio can opt for passive funds.
